Why You Should Invest in Ethical Companies

Ethical investing (also known as ESG investing) is a strategy that involves filtering and selecting investments based on your personal code. Investors who choose ethical investments strive to support companies and industries working toward goals that are important to them and provide decent returns.

Of course, this means that what is “ethical” depends on your individual moral code.

For instance, ESG investors pick companies that promote environmental, social, or governance causes, or with positive track records in one or all of those areas. But some investors simply shy away from (or go in on companies that work against) “sin stocks” that engage in tobacco, alcohol, or firearms production or distribution.

The first recorded instance of ethical investing actually took a religious bent, when 18th century Quakers restricted members from spending money or time in the slave trade. In the same period, one of the Methodist founders preached the importance of abstaining from investments that harm one’s neighbors, such as chemical plants.

Since then, ethical investing has grown and branched to take on several forms, including ESG, SRI, and impact investing. Throughout the past two centuries, many ethical investments mirrored the political and social trends of the time. And as the niche has developed, ethical investing has increasingly focused on industries or institutions that impact the environment and society in the modern age.

TL;DR

  • Ethical investing involves selecting companies that fit into your personal value system
  • ESG and SRI investing both fit under the umbrella of ethical investing; but ethical investing tends to be more personalized than just environmentally or socially impactful
  • Ethical investors may abstain from “sin stocks” that engage in activities such as alcohol, tobacco, or firearms production or distribution, or go in on stocks that actively work to reduce these activities

Value. Growth. Momentum. Dollar-cost averaging. Question: What do all these words have in common? Answer: They’re all investment strategies.

But just because we gather these strategies into tidy little boxes and slap a label on them doesn’t mean that they’re one-size-fits-all. In fact, there are as many ways to invest as there are people in the world, as every investor can mix and match strategies, investments, time horizons, and risk tolerances to suit their needs.

One box that we didn’t mention is ethical investing. This strategy goes by many names and encompasses many styles, but the important underlying component is that ethical investing puts your dollars to work where your values are. By aligning your moral compass with your investment portfolio, you can ensure that, in your own way, you’re doing some good in the world – and hopefully making a profit on it, too.

What’s the Difference Between Ethical Investing and ESG Investing and SRI Investing?

There isn’t a difference. In fact, environmental, social, and governance (ESG) investing, socially responsible investing (SRI), sustainable investing, green investing, impact investing, and others in similar veins all fit under the umbrella of “ethical investing.”

Of course, the specifics in each type of investing may vary, and many of these work toward larger goals, rather than personalized moral codes. But the underlying intent remains the same: to invest in institutions that align with, work toward, and promote shared values and positive impacts.

That said, investing ethically can take two forms: exclusionary or inclusionary. (There’s also a third form that mixed the two strategies). In exclusionary investing, you abstain from putting your dollars into companies that work against your values. But in inclusionary investing, you put your money into businesses that work toward your goals.

To give an example one environmentally friendly fund may exclude companies that engage in oil production, burn coal, or have a history of dumping toxic wastes. But another may seek out companies that offset their carbon footprints, build solar panels, or donate to environmental causes. Some funds use both methods to determine which companies qualify on a case-by-case basis.

Keep in mind, too, that the names for this type of investing can be applied to any number of strategies. As such, it’s essential to do your research to ensure that your investments aren’t making false claims or mislabeling their investments.

For instance, a fund that excludes companies in the tobacco trade could call itself “sustainable” without repercussion – but it wouldn’t fit an investor’s environmentally friendly strategy.

Moreover, it’s a good idea to note where an investment falls along the ESG curve, as many ethical companies or funds use ESG factors to “grade” their performance.

The Benefits of Investing Ethically

Investing in ethical companies can come with both personal and financial benefits. Not only are you (hopefully) earning money on your investments, but you can rest easy knowing that your money is funding causes you believe in. Plus, adding an ethical component to your portfolio allows you to further diversify your investments.

But that’s not all. Now, there are no guarantees in investing, and past performance may not be indicative of future results.

That said, many ethical investments have matched or even outperformed traditional investments when it comes to returns. In fact, on an elongated horizon, some ethical funds may be financially superior.

The reason is simple: companies that focus on environmental, social, or governance issues are less likely to engage in scandalous behavior. 

For example, companies with an environmentally friendly bent are less likely to have an oil spill or mismanage their toxic waste, thus avoiding massive fines from the outset. And institutions that champion social justice reform may avoid scandals related to sexual assault or women’s and minority rights issues, leading to fewer lawsuits.

Interestingly, Covid-19 pandemic market data has even shed light on evidence that suggests ethical funds may be less risky in volatile economic periods than traditional funds. According to Morningstar, 3 out of 4 sustainable equity funds beat their Morningstar Category average. Moreover, 25 out of 26 ESG equity funds beat index funds tracking the most common traditional benchmarks.

That doesn’t mean that ethical funds will always outperform or perform at all, of course. Nor does it mean that there’s no place in a portfolio for traditional investments. However, this data does show that ethical investments may have a place in hedging against their index counterparts, at the very least.

Building an Ethical Portfolio

If you’re ready to build an ethical portfolio for the first time – or update your existing one – answering a few simple questions can put you on the right path.

What Does “Ethical” Mean to You?

To start, you’ll want to define what an “ethical” company looks like.

Are you interest in broad-strokes ESG investing, or do you want to focus on social issues? Would you put your money into any company with a high ESG rating in your preferred category, such as environmental investing, or do you only want companies that work in specific niches, like alternate energy?

When you break it down further, would you be willing to invest in oil companies that also invest in solar energy, or is oil out completely? What about socially responsible companies who have in the past or continue to donate to anti-civil rights lawmakers?

Answering these questions – and any others that may crop up – is essential to figuring out where the line between ethical and unethical lies for you.

How Will You Invest?

Next, you’ll have to decide if you want to build your portfolio yourself or enlist the help of a financial or robo-advisor.

Building your portfolio has some advantages – namely, you get to select your investments yourself. However, it’s also time-consuming and requires a lot of research to ensure you’re making the best decisions.

Some brokerages may be able to help you build your portfolio from scratch with their in-house algorithms, of course. And many robo-advisors include premade and fully managed SRI or ESG funds from the get-go, saving you a lot of time.

However, while robo-advisors in particular are one of the cheapest and quickest ways to get ethically invested, most of them don’t allow you to select specific stocks or funds.

Where Will You Invest?

Once you’ve decided how you’ll invest, the last step is to find your investments and fund your account. If you’re getting started with a robo-advisor or broker, research which brokerages have ESG, SRI, or other ethical funds that best fit your needs.

If you’re building a portfolio on your own, look to ETFs and mutual funds that focus on the issues close to your heart. (Be sure to check that each fund actually fits within your selected parameters, rather than just throwing an SRI label on a basket of oil stocks!)

Additionally, take a look at each fund’s prospectus to examine its expense ratio and holdings.

And while loading up on individual stocks is typically not advised, adding a few shares here and there from companies with impressive sustainability reports may help you round out your portfolio and put your money into companies you believe are making an outsize difference. 

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