Is My 401(k) Environmentally Friendly?

Pro-environmental options are more available now for workers who want their 401(k) investments to be more sustainable. However, most plans still don’t have environmentally friendly options. There’s a lot of money that could go into such plans if they were available.

Three-fourths of employees have access to a 401(k) or similar employer-sponsored retirement savings plan, according to the Transamerica Center for Retirement Studies, a private foundation that studies retirement security and financial well-being. The 401(k) market represents significant value, about $6.3 trillion in assets, says the Investment Company Institute, a regulated investment funds association.

If you want to make sure that your retirement investments aren’t juicing the fossil-fuel industry, it may mean talking with the investment manager for your 401(k) or opening a self-directed brokerage account.

401(k)s and Fossil Fuels

If you have a 401(k), it probably isn’t eco-friendly. Very few funds offer green options, and even fewer people are invested in them. Despite big talk from companies about countering climate change, analysis of the retirement plans of some of the major S&P 500 companies has found that they invest heavily in coal, oil, and gas. Only a few offer sustainable options. This means that a lot of people have been investing in fossil fuels, perhaps without knowing it.

Happily, there has been a growing push for divesting 401(k)s from fossil fuels. Big-name divestments in the last couple of years from institutions with financial and cultural heft include the University of California system and Harvard University. The government’s 401(k) equivalent program for federal workers, the Thrift Savings Plan (TSP)—which controls more than $827 million in assets under management—is also moving to introduce environmental, social, and governance (ESG) investing options.

However, even those who are pushing these institutions to drop fossil fuels have said that they have a hard time making sure their investments are carbon neutral.

ESG Investing

Outside of advocating for fossil-fuel divestment, the main option for supporting the environment through retirement savings is ESG investing. This type of analysis clarifies companies’ environmental, social, and governance practices. Despite concerns about a possible ESG “bubble” and the notion that they don’t perform as well, ESGs have exploded in the past couple of years. They’re not mandatory, but a lot of companies are making them.

One reason for the ties between 401(k)s and fossil fuels is that fund managers are obligated to pick investments based on returns. The potential risks of future climate disaster on financial returns have been excluded from consideration.

There has been legislative uncertainty as well. In 2020, the then-Trump administration restricted the ability of managers to use “nonfinancial” considerations in picking which funds to invest 401(k)s in, discouraging fiduciaries from embracing ESG factors. That’s been undone by the Biden administration. Fiduciaries are now allowed to offer sustainable investment options, but the person picking the plan must still stay true to risk-return factors.

There are also concerns about the actual content of ESG funds. For example, an investigation of a leading rating company, MSCI Inc., reflected poorly on its ability to vet stocks effectively, prompting concerns over greenwashing. In response, advisors such as the Carbon Collective are working on indexes.

Surveying the Field

Your company may offer a green investment plan. If it does, picking it is simple. If not, you can talk to the investment manager to figure out your options. It could be that asking repeatedly for green investments can lead to them being introduced. Ultimately, though, it may require some lobbying.

Another possibility is opening a self-directed brokerage account, which gives you greater choice in where your investments go by letting you trade in securities. These accounts give you greater investment flexibility, though not everyone allows them, and there are risks. If you do set up this sort of account, you can use an index, such as the Fossil Free Funds index mentioned above, to figure out where to invest.

The Bottom Line

Retirement investments represent a lot of capital in the United States. Slowly, activists and investors are working to expand green retirement savings options.

It’s part of the movement for environmentally friendly capitalism, characterized by the claim that being good for the environment and social outcomes does not mean that you have to sacrifice financial returns. However, it’s still in its early days.