Today’s question comes from Justin in Mason, Iowa…
“I’ve been learning about carbon credits and the emerging carbon credit space. And to me, it seems like an opportunity for some good returns if I can figure out the best way to invest in this space.
And I came across carbon mutual funds and ETFs. So I was wondering what you guys know about carbon mutual funds and ETFs. Are there any you would recommend?”
Matt & Joel’s response: Thanks for the question, Justin!
We hate to burst your bubble, but the truth is, we really don’t recommend people invest in alternative funds like this at all.
I guess if you’re putting a tiny amount of “play money” into a carbon fund for kicks, that’s ok. But it should be a really smal portion of your portfolio.
For building long term wealth, we recommend the standard meat and potatoes investments. They might be boring, but they get the job done. Index funds are what you should stick with.
Contributions > Returns
We often hear people asking about investing in alternative assets or attempting to invest for a higher return. In many of those cases, those investors have a meager savings rate.
And since they are saving/investing less money, they’re trying to pick magical investments with the hope that their outsized returns will make up for that lack of savings. They want their balance to grow quickly and so they opt to take on more risk than makes sense.
But looking for outsized returns in sexy places isn’t actually the best route to take.
Savings rates trump investment returns all day, every day. Someone saving 20% of their paycheck and only making a 5% return each year, will grow a bigger pile of wealth than someone saving 1% of their paycheck and making a 10% return.
Also, your savings rate is something that is in your control. Investment returns are not.
So the first thing you should focus on is your overall savings rate before you start to consider more novel investing options. Chasing returns – even if the funds sounds really promising – isn’t a smart long-term strategy.
Unnecessary Risk
Risk is a crucial part of investing. In general, the more risky the investment, the higher the potential returns.
But that doesn’t mean we need to always invest in niche ways to try and juice returns. With high risk comes a higher probability of volatility.
Instead, let the process of dollar cost averaging and time in the market do its job!
My guess is that most people haven’t seen much out there on this topic of investing in carbon credits. That’s because it truly is incredibly niche.
It’s been said that finding the right niche will make you rich. And that might be true in some cases, but I think it’s more about being a top 1%er in your profession than investing in off the wall things.
Higher Fees, Lower Performance
Let’s talk about the crucial element of costs for a second. That’s an important part of the investing decision too.
One of the main problems with funds that will allow you to invest in carbon credits & futures is the incredibly high expense ratio they come with.
The most popular ones have an almost 0.8% expense ratio! And they have underperformed a diversified mix of stocks by quite a bit in recent history.
Past returns aren’t indicative of future results, of course, but it’s really hard to overcome the much higher expense you’ll pay.
Policy Changes
Another potential downside to investing in things like carbon credits is changing government policies. Government interference can wreck your investments overnight!
Think about tech companies vs. Europe. The EU has held the microscope to companies like Facebook and Apple. Not that those companies don’t deserve regulation or government oversight, but it would give me some pause before I decided to invest a major chunk of change into any single tech stock.
Diversification, owning those companies within the confines of an index fund, gives you access to significant upside while limiting the downside possibilities.
Keep Investing Simple
Simplicity is also a crucial factor in growing your wealth pile.
We’re not against sector investing or having some exposure to single stocks. But that can create more complexity. Modern humans are busy creatures. Is that added complexity really worth it!?
Let the incredibly boring stuff do the heavy lifting for you. Broad, low cost index funds are the right choice for most DIY wealth-builders.
The fun stuff like meme stocks, random crypto coins, and sexy alt assets will spice up your investing portfolio. They make it more fun to pay attention to and to mess with. But if your ultimate goal is building wealth, those perks are the opposite of what we’re shooting for!
The Bottom Line:
Unless you’re already crushing your financial game and way ahead on the investing front, we wouldn’t recommend messing around with carbon credit ETFs or mutual funds. The risk isn’t worth the potential reward.
Instead, focus on socking away more of your paycheck and funneling it into boring, proven funds. Low cost, diversified index funds are a stellar choice for folks in the wealth-building phase of their lives. You’ll be able to grow your pile without taking up too much of your precious brain space.
For the full version of this discussion, check out Podcast Episode #853 (it’s the 3rd question in the episode)
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