ESG in Your 401(k): Why It’s Okay to Care—and Still Worth Comparing the Numbers

Let’s start with this: if investing in companies that align with your values helps you  sleep better at night, then that’s worth something. Seriously. 

Some people care deeply about environmental, social, and governance (ESG) factors. They  want to avoid investing in companies that pollute, treat workers unfairly, or have  questionable leadership. And we respect that. If putting your money behind companies you  believe in brings peace of mind—even at the cost of slightly lower returns—then it might  be the right decision for you. 

But here’s the thing: a lot of ESG investments—especially those inside employer sponsored retirement plans like 401(k)s—haven’t performed as well as traditional  investments. And over the long haul, even a small gap in performance can make a very  big difference in your retirement nest egg. 

So in this post, we’ll explore: 

• What ESG investing is (and isn’t) 

• How ESG funds have stacked up against the S&P 500 

• What a 1% difference in returns really costs you over time 

• And how to balance values with long-term growth 

What Does “ESG” Mean, Anyway? 

ESG stands for Environmental, Social, and Governance. These are the three categories  used to evaluate a company’s ethics or sustainability practices. 

• Environmental: How does the company impact the planet? (e.g., carbon  emissions, renewable energy use) 

• Social: How does it treat people? (e.g., employee rights, diversity, community  involvement) 

• Governance: How is the company run? (e.g., leadership ethics, executive pay,  transparency) 

ESG funds try to invest in companies that score well in these areas. Some funds are very  strict, excluding entire industries like oil, tobacco, or firearms. Others are more flexible.

In recent years, more 401(k) plans have added ESG options—either because employees  asked for them or because plan sponsors wanted to align with sustainability trends. 

But here's the catch: doing good doesn’t always mean doing well (financially speaking). 

ESG vs. S&P 500: How the Numbers Stack Up 

Let’s take a look at the S&P 500 (a common benchmark for U.S. large-cap stocks) versus a  popular ESG version of it: the iShares ESG Aware MSCI USA ETF (ticker: ESGU). 

At a glance, ESGU looks very similar to the S&P 500. It includes many of the same  companies—like Apple, Microsoft, and Google—but excludes or underweights others that  score poorly on ESG metrics. 

Historical Returns (as of mid-2025): 

Fund 5-Year Annualized Return 10-Year Annualized Return S&P 500 (SPY or VOO) ~12.2% ~11.9% 

ESGU (iShares ESG Aware ETF) ~11.1% ~10.8% 

That’s about a 1% difference per year. 

That might not sound like much, but over time, compound interest makes that 1% gap  enormous. 

The Real Cost of a 1% Difference 

Let’s say you’re 35 years old today, and you plan to retire at 65. You invest $10,000 per year into your 401(k). Let’s assume the investments grow tax-deferred (as they do in a traditional  401(k)), and you’re comparing two portfolios: 

• Portfolio A: Grows at 12% per year (S&P 500 average) 

• Portfolio B: Grows at 11% per year (ESG average) 

After 30 Years of Saving: 

• Portfolio A (12% growth): $2,957,000 

• Portfolio B (11% growth): $2,318,000

• Difference: $639,000 

That’s not pocket change. 

Even just a 1% difference in returns adds up to over $600,000 less by retirement. That  could be the difference between retiring at 65 vs. 70, or between a worry-free retirement vs.  one with tighter constraints. 

This is why financial advisors often emphasize the power of long-term growth and  compounding. 

Why ESG Funds Tend to Underperform 

Here are a few reasons ESG funds inside retirement plans have historically  underperformed: 

1. Limited Diversification: 

Many ESG funds exclude large swaths of the market (like energy, defense, or certain  manufacturing sectors). That limits diversification, which can increase risk or  reduce potential returns. 

2. Higher Costs: 

Some ESG funds carry higher expense ratios due to more complex screening and  research processes. Even a slightly higher fee can eat into long-term growth. 

3. Performance Drag from Exclusions: 

Over the last decade, some of the best-performing sectors—like energy and  financials—have been underweighted or excluded in many ESG portfolios. That  hurts performance during certain market cycles. 

4. Inconsistent Standards: 

There’s no universal definition of “ESG.” Different funds use different criteria, which  leads to wildly different portfolios—even among funds with “ESG” in the name. 

What About the Lawsuits? 

As ESG investing has gained popularity, it’s also drawn legal scrutiny—especially when it  comes to retirement plans. One example: in 2022, participants in American Airlines’ 401(k)  plan filed a lawsuit claiming the company violated its fiduciary duty by offering an  underperforming ESG fund. They argued that the fund’s focus on social and environmental 

goals came at the expense of returns—something retirement plan sponsors are legally  required to prioritize under ERISA (the Employee Retirement Income Security Act). Another  major case came in 2023, when Texas sued BlackRock and other asset managers, accusing  them of putting ESG priorities—like avoiding fossil fuels—ahead of financial performance.  These lawsuits highlight a key issue: fiduciary responsibility.  

Under ERISA, plan sponsors must act solely in the best financial interests of plan  participants. If ESG considerations result in lower expected returns or higher risk, that  could be a legal problem—not just an investment preference. Whether you’re a fan of ESG  or not, it’s worth asking: does the fund belong in your 401(k), or is there a better place for  values-based investing? 

So… Should You Avoid ESG Funds? 

Not necessarily. 

If you care deeply about how your money is invested, and you're comfortable potentially  trading a bit of return for that peace of mind, ESG can be a perfectly reasonable choice. 

Here’s what we tell clients: 

Values matter. But so do numbers—especially when it comes to retirement. The key is understanding the trade-offs and making an informed decision. If you’re thinking about using ESG funds inside your 401(k), consider: 

• How big is the return gap? 

• Is this ESG fund diversified enough? 

• What are the fees? 

• Do you have ESG preferences in just part of your portfolio, or all of it? • Is your long-term retirement plan still on track? 

A Values-and-Returns Approach 

You don’t have to go “all in” or “all out” on ESG. 

Some people choose to invest the majority of their retirement savings in traditional index  funds—like the S&P 500 or a target-date fund—and then invest a smaller portion of their 

portfolio (like in a Roth IRA or brokerage account) in ESG-focused funds or individual  companies they believe in. 

That way, you’re not putting your entire nest egg at risk of underperformance, but you’re still  supporting causes you care about. 

Bottom Line: It’s Your Money and Your Call 

Investing according to your values can bring peace of mind—but when it’s done inside your  401(k), it might be quietly costing you more than you think. In this post, we compare ESG focused funds to traditional benchmarks like the S&P 500 and show what a 1% difference  in returns could mean over 30 years. If you’re trying to retire comfortably, you’ll want to see  this. 

Let’s Talk About It 

Everyone’s retirement journey is personal. We’re not here to tell you what you should believe in—but we do want to make sure your investments are working as hard as you are. 

If you're wondering how ESG fits into your retirement plan—or whether your 401(k) is really  optimized for growth—we’d love to help. 

 Reach out for a no-pressure conversation. 

 Or just send us your questions—we’re happy to explain in plain English. 

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