What Is Ethical Investing?
Ethical investing is a strategy wherein you allocate your investment dollars according to your beliefs. For example, if you’re a supporter of environmental causes, you can consciously avoid investing in oil companies or other ecologically damaging businesses.
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Ethical investing, also known as socially responsible or sustainable investing, has grown in popularity in recent years. As a result, in addition to selecting your own individual equities, you can also invest ethically via a number of different mutual funds or exchange-traded funds.
Here’s a quick overview of ethical investing, including its pros and cons.
Is Ethical Investing the Same as ESG Investing?
Environmental, social and governance investing — ESG investing — is similar to ethical investing in that both involve investing in companies that practice sustainability and responsibility. Where the strategies differ is in their investment goals.
Ethical investors’ first priority is to support certain moral or socially responsible practices by investing in the companies that engage in them. ESG investors also look at corporate responsibility, but they do so with the belief that companies with responsible environmental, social and governance policies avoid risk and stand to generate greater returns for investors as a result. So while ethical investors focus on sustainability, ESG investors focus on the profits likely to result from sustainability.
Another difference is in who determines whether a particular company makes a sound ethical or ESG investment. You’ll likely make ethical-investment decisions based on your own personal values. ESG is more objective in that it can be measured using data. The Wall Street firm Moody’s, for example, uses ESG data in its risk-assessment analyses.
Despite their differences, ethical investing and ESG investing are not mutually exclusive. An ESG investment can also be an ethical investment if it aligns with your ethical values.
Advantages of Ethical Investing
The primary advantage of ethical investing is that you can sleep at night knowing you are supporting companies that share your principles. Rather than profiting from companies that engage in practices you consider to be unethical, your investment supports businesses that you believe in.
Additionally, the more investors who vote with their wallets and invest in sustainable companies, the more capital those companies will attract, which can result in real change. Just take a look at how electric vehicles have moved relatively swiftly from an “environmental-only” investment to the mainstream. The same can happen for other industries with enough investor support.
Disadvantages of Ethical Investing
The primary disadvantage of ethical investing is that it by definition narrows your investment universe. As an investor, your goal is usually to generate the biggest profits you can, but if you’re limited in the choices you can make, you might miss out on some great opportunities to generate gains.
For example, let’s say you’ve limited your investment universe to companies that generate clean water. This means you won’t be investing in companies like AppFolio, which has gained nearly 36% this year as of April 28, or SkyWest, which has posted a 56% gain as of the same date.
What Types of Ethical Investments Can You Make?
Ethical investing is a fairly broad strategy, but you can break it down into categories devoted to different aspects of it. Here are some examples of types of ethical investments to consider:
Impact investments: Fidelity Charitable defines impact investments as those that “help achieve certain social and environmental benefits while generating financial returns.” Impact investing might include specifically choosing or excluding a company based on how its practices align with your values. Or you might donate to a socially responsible project that needs capital.
Socially responsible investments: SRIs support companies focused on positive social change as a primary goal. Return on investment is a secondary consideration.
Environmental, social and governance investments: ESG investments place primary importance on returns, but they seek them from companies with sound ESG policies.
Faith-based investments: Faith-based investing aligns with investors’ religious beliefs. As with broader impact investing, faith-based investments might specifically include or exclude companies based on your religious values.
How To Build an Ethical Investment Portfolio
In decades past, ethical investors had to sift through reams of information to determine which individual stocks they could buy. Nowadays, socially responsible investing has become an asset class in and of itself. Numerous mutual funds and ETFs are available for these types of investors to select, complete with well-defined investment objectives and listings of individual holdings. In other words, there’s never been a better time to be an ethical investor, at least in terms of available investment options.
Seeking Alpha offers advice on how to get started:
Determine what ethical investing means to you. What kinds of companies, industries or practices do you want to support — or avoid?
Decide how to invest. Do you want to build a portfolio of individual stocks, or would you prefer to invest in themed funds containing a basket of individual stocks?
Research stocks and/or funds. You can find plenty of free research on online brokerage sites about companies and funds, including fund objectives and ESG scores.
Create your ethical portfolio. Buy the stocks and/or funds you want to invest in.
Does Ethical Investing Work?
Ethical investing certainly “works” in the sense that it draws attention to how investors can vote with their money, and it provides financial support for companies in sustainable industries.
As to whether ethical investing can consistently outperform the market, the jury is still out. There will certainly be years in which these types of companies perform remarkably well. In 2020, for example, electric vehicle maker Tesla was the single best-performing stock in the entire market, returning over 740%.
However, there will always be investors who seek the highest available return in the market, and this money may or may not flow into sustainable stocks. While ethical investors can seek out the highest-performing stocks, funds or ETFs within that investment universe, their first priority is usually to invest only in stocks that match their ethical principles.
John Csiszar contributed to the reporting for this article.
This article originally appeared on GOBankingRates.com: What Is Ethical Investing?
