Top 7 Rules for Investing in Green Funds

Every time gas prices go up, more investors pile into green funds. Every time environmental issues heat up, so do the number of green funds. And as the …

Every time gas prices go up, more investors pile into green funds. Every time environmental issues heat up, so do the number of green funds. And as the number of green companies increase, so do the dollars in green funds.

“Green funds tend to be focused on companies of the future,” said Steve Schueth, president, First Affirmative Financial Network, which specializes in socially responsible investments. “They’re popping up like mushrooms after a morning rainstorm.”

Investors are also popping up like mushrooms, pouring trillions of dollars into green funds. As the demand for alternative fuels and clean technology grows, the potential for return continues to grow. But the green market is young and volatile, said investment experts, and investors need to manage their investments wisely in order to realize returns.

“They’ll need the stomach to pass the dramatic swings in performance and keep a longer term view,” said Michael Herbst, an analyst covering green funds at Morningstar, a leading investment research firm. Morningstar has 38 green funds in its database.

Green companies are involved in helping the environment by creating alternative energy sources, such as wind, solar or thermal. Or they might be involved in cleaning up carbon footprints. Or they might lead their industries in producing goods and services in energy-efficient ways.

These are the seven rules for investing in green funds:

Rule #1 – Choose a good broker

You can choose a professional investment advisor or you can do it yourself. If you choose a broker, find someone who is experienced in green stocks and who is committed to its values. You also want to find someone with a CIMA certification so that you know for sure that they’re qualified to guide you in your decision making.

Some Web sites post directories of green fund advisors. First Affirmative Financial Network, at, lists 120 socially-responsible investment advisors nationwide. The Social Investment Forum, at, posts 250 advisors. Other mainstream investment firms—such as Merrill Lynch, Credit Suisse and Morgan Stanley—now also offer socially-responsible investing funds as part of their general investment instruments. But their experience with green funds is limited.

If you decide to be your own broker, make sure you do lots of research.

Rule #2 – Know your investment values

Are there certain types of companies that you want to avoid? For instance, some investors avoid companies that sell tobacco, alcohol, military equipment or nuclear energy. Conversely, what types of companies do you want to support? Some investors prefer companies that help the environment, as well as have good management practices.

For example, Wal-Mart has some very progressive policies in terms of saving energy, but some investors question their employee benefits. Corporate monolith GE is involved in wind and thermal energy, but is also developing nuclear energy, which some investors object to.

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You need to determine what is acceptable or not acceptable to you.

Rule #3 – Understand the funds

Investors also need to look carefully at products before putting in money. This includes understanding the fund’s parent company, investment goals, track record and criteria, said Schueth. “Due diligence on these new products is really critically important…to realize whether you’re being ‘greenwashed’ or not.”

You also want to understand the breadth and width of a fund. A “pure” energy fund might focus on one market sector, such as water-energy companies. A broad-based fund might include large companies that are industry leaders in green practices. For example, 3M—which makes Sticky Notes—is not considered a “green” company, but it has significantly improved its energy efficiency in the last decade, making it a “best-in-class” leader.

Investors also want to understand the fund type. Green funds are either mutual funds or exchange-traded funds, called ETFs. Mutual funds are baskets of stocks, chosen by money managers, with fixed share prices at the end of each trading day. ETFs are stock selections based on indexes and can trade anytime, making them cheaper and more flexible.

You can find out more about different funds at investment research sites, such as,, and Yahoo! Finance.

Rule #4 – Know your risk tolerance

Your risk tolerance level will determine how much weight to put in your various portfolio holdings. Younger investors, with decades of working years ahead, tend to have higher risk tolerance. Older investors, who may need more income, generally have lower risk tolerance.

If you have high tolerance, you will want an aggressive portfolio with more U.S. and international stocks and no bonds.  This might consist of 73 percent U.S. stocks, 24 percent international and three percent short-term liquid investments, according to, which offers a risk tolerance test.

If you have low risk tolerance, you will prefer something with more blue-chip US stocks and bonds. A conservative portfolio might consist of 42 percent short-term liquid investments, 29 percent bonds, 24 percent U.S. stocks and 5 percent international stocks, according to

Green funds can fit into any of those asset areas—U.S., international, blue-chip, small-cap, stocks or bonds. “Asset allocation is going to determine 70 percent to 90 percent of performance,” said Arturo Tabuenco, founder, Blue Marble Investments, which runs “Because it’s green or not doesn’t make a difference.”

Rule #5 – Limit your allocation

Many green companies are still new and small, with unpredictable profits. If one company goes bankrupt, it can drag down an entire fund. Therefore, financial advisors say to limit the amount you invest in green funds.

First Affirmative’s Schueth recommends that most investors not put more than 7 percent of their total portfolio—or 10 percent for extremely wealthy investors—into green funds.

“The idea of being too concentrated in a relatively new, highly-volatile, fairly small-cap area is not something most people should be doing,” said Schueth.

Rule #6 – Be prepared for volatility

Green funds can typically be as high or low as much as 50 to 130 percent a year. The Dow Jones World Solar Energy ETF was up by nearly 135 percent in 2007 and down nearly 16 percent as of August 25 this year. The WilderHill Clean Energy ETF was up 58 percent last year and down nearly 31 percent as of August 25 this year.

In contrast, the S&P 500 was up 5 percent in 2007, and down 12 percent by Aug 25 this year, according to Morningstar.

Some funds simply evaporate. One fund, ThinkGreen by ThinkCapital, was launched in April this year and liquidated in August.

“Performance for these funds is likely to remain volatile and unpredictable,” said Morningstar’s Herbst. “Investors (should) view them as specialty holdings, rather than core holdings.”

Rule #7 – Stay for the long term

Investment advisors said to plan to invest for at least five years. In a volatile market, this timeframe is needed to see healthy returns.

With volatile stocks, “Many investors tend to buy high and sell low, which is essentially the opposite of what they should be doing,” said analyst Herbst. He noted that many green fund investors got in at the market height in fall 2007, and then sold in January this year, when many funds dropped 20 percent. These investors “actually captured the entire loss and missed out on any potential rebound and eventual gains those funds may very well have in the future,” he said.

Herbst notes that many wealthy investors in the green space plan on five- to seven-year holdings. “Some of these opportunities will only be realized in the long term,” he said.

First Affirmative’s Schueth advises clients to stay at least five years. “In our opinion, that’s the only way to invest,” he said.

Several of these rules apply to any good portfolio. But they become more acute when investing in green funds, which are relatively young. Like tech stocks of the late 90s, green funds have the potential for great returns, as well as great losses. “Let the buyer beware,” said analyst Herbst.

For a listing of green mutual funds and green ETFs, see our chart: Green Mutual Funds and ETFs. For more information, read our previous articles: Clean Technology “Boom?&quot and Green Investing Gold Rush.


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