Impact investing has become a hot topic among donors and financial investors alike. But what does it mean, and why might you consider it as a philanthropic option? Broadly defined, impact investing means investing capital to generate social impact in a way that also provides monetary returns. These returns may vary from the initial principal amount upward (or, potentially, downward), depending on the nature of the investment.

Impact investing offers an alternative to philanthropists who reject the notion that there is a binary decision between investing for profit and giving money to a social cause. While traditional grantmaking often overcomes market-based failures, impact investing leverages the power of markets to create change. As you think about the social problems you seek to address, consider impact investing as one of the many tools at your disposal. However, keep in mind that impact investing is in its infancy and relatively unproven.

Impact investing is an umbrella term that encompasses vehicles for a wide range of investors. For example, a microfinance investor, a green-tech venture capitalist, and a low-income housing lender are all potential impact investors. The Monitor Institute notes that impact investors can be broadly categorized into two groups:

  • Financial first investors seek to optimize financial returns, while also aspiring to achieve social or environmental impact. This group tends to consist of commercial investors who search for investment vehicles that offer market-rate returns that also yield some social/environmental good.
  • Impact first investors prioritize social or environmental returns on their investments over monetary returns, while still expecting some financial return. This group uses social/ environmental good as a primary objective and may accept a range of returns, from return of principal to market rate. These investors are also willing to shoulder more risk in order to reach social/environmental goals that cannot be achieved in combination with financial returns at market rates.

Read the full article about impact investing at The Bridgespan Group.