As the income inequality gap rises between the rich and poor, so does the gap in financial services available to the economic mainstream and those offered to low income individuals and communities. Community Investing is a branch of the socially responsible investing movement that attempts to bridge this gap by financing resources and opportunities for those typically under-served by traditional financial institutions. It creates a way for investors to get a return on their money as they contribute to the causes they care about and the community they live in. Community investments work to create jobs, supply capital for small businesses, provide financial services to low-income individuals, support affordable housing initiatives, and contribute to other community services. It can be used to finance needed services, economic development, sustainable communities, and a host of other creative initiatives.
How does it work?
Community investing works similarly to a loan, with a few key differences. The investors invest money in a community development financial institution(CDFI). The CDFI then lends money to borrowers, as a bank does, but the borrowers are small businesses, farms, individuals, or non-profits who are typically unable to receive a traditional bank loan. In return, the CDFI pays back the investors with interest and the principal at the maturity of the loan. The following chart from Opportunity Resource Funds demonstrates this idea.
Where does the money go?
CDFIs lend money to a variety of different borrowers. Each CDFI may use different criteria and targets in order to determine who the investments reach. For example, local CDFI Forward Community Investments (FCI) focuses on making social change and progress within Wisconsin communities. FCI uses a thorough selection process, using criteria such as the project’s social and proposed economic impact, affordability (potential to provide low cost goods and services for the community), level of demonstrated community support, community demographics, utilization of “green” development techniques or operation strategies, use of local labor for construction or real estate, and use of minority business enterprise (MBE) firms for construction and professional services.
Yes. Using FCI as an example again, their investors are currently offered a 2% annual return, with annual interest payments. In comparison, the yield on a 1 year treasury is currently less than one percent. Thus, community investing can make sense not only ethically, but financially. This is the big difference between community investing and donations. Investors expect to get their money back, as well as a return on their investment. Community investing promotes responsibility and sustainability by encouraging borrower's independence, rather than a dependence on goodwill donations.
What are the risks?
As with any investment, there is risk involved. Two of the bigger ones in community investment are default risk and liquidity risk. Default happens when someone cannot pay back the loan and there is a risk of a complete loss of principal. However, the default rate on CDFIs are actually quite low and they tend to have loan loss reserve to help guard against losses. Liquidity refers to how quickly something can be turned to cash. Liquidity risk happens when the money you invest isn't easily accessible when you need it. More common market investments, that trade on an exchange, tend to have high liquidity where investors can sell their investment if or when needed. With many community investments, there is no liquidity until the investment matures, meaning that investors cannot sell their investment or get the principal amount on the loan back until the term has ended.
How do I get involved?
You can check your local area for a Community Development Financial Institution, but we recommend doing some due diligence to understand their operations, risks, and agreement with you as an investor. You should also consider involving your trusted accounting, legal, and financial professionals with the review process before doing any investing. If you are interested in community investing and want to see how it can fit into your current investment portfolio, we can help with our complimentary consultation. Email us at email@example.com request more information or set up your appointment today.
This information is for educational purposes only and is not an offer to buy or sell, nor a solicitation of any offer to buy or sell the securities mentioned herein, or considered to be the rendering of personalized investment advice. Past performance is no guarantee of future results. Therefore, no reader should assume that future performance of any specific investment or strategy (including the investments and/or strategies discussed), will be profitable or equal to past performance levels. Conscious Capital Management, LLC assumes no responsibility for loss or damages resulting from the use of this information. A professional advisor should always be consulted before implementing any of the options presented.