Investing

Ethical Investing: What It Is and How It Works

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You may have heard “vote with your dollars” when choosing clothing companies or political campaigns to support. But you can do the same with your investment dollars using ethical investing.

Ethical investing is a strategy that aligns your values and wallet with companies that share your values. And you can build your ethical portfolio using multiple resources, including single stocks, mutual funds, index funds and robo-advisors.

What is ethical investing?

Ethical investing is a strategy where you consider the ethics of a company’s business practices alongside its profit potential. Of course, what is considered “ethical” can differ from person to person. However, ethical investing usually means backing companies working to help society.

For example, you might consider a company or investment ethical if it supports:

  • Environmental initiatives, like green energy and sustainable fishing practices.
  • Social initiatives, like those that support women in the workplace or reinvest in their local community.
  • Health initiatives, which may exclude investments in companies in the alcohol, tobacco or gambling industries.
  • Religious values, like companies with practices and policies that align with your spiritual beliefs.

Ethical investment practices let you align your investing dollars with companies building the world you want to see.

Types of ethical investing

There are many different types of ethical investing. You can use one or several to build an investment portfolio that supports your values.

Impact investing

According to the Global Impact Investing Network (GIIN), impact investments are those you make to generate positive returns while promoting a measurable social and environmental impact.

If you choose to become an impact investor, you’ll typically:

  • Set social and environmental objectives for your investments.
  • Set performance metrics to ensure your investments meet your objectives.
  • Choose investments that provide reporting on social and environmental impact.

If you’re curious about how to find impact investing options, hang tight. We cover this in a section to come.

Exclusionary investing

Exclusionary investing excludes companies or investment products because they don’t align with your values. You can use exclusionary investing in two approaches: pure exclusion and best in class.

With a pure exclusion approach, you actively choose not to invest in either individual companies or entire sectors. For example, you may avoid tobacco investments because of the health risks those companies present to the public.

With a best-in-class approach, you might not rule out all oil companies because of potential harm to the environment. Instead, you may choose the oil company with the lowest carbon footprint or the largest investment in clean energy initiatives.

Environmental, social and governance (ESG) investing

ESG-minded investors consider a company’s commitment to three key areas:

  • Environment. How do this company’s business practices impact the local and global environment? This could include shipping practices and wastewater practices.
  • Social. How does a company treat its employees, and how do its policies impact the surrounding community? This could include charitable activities or commuting policies that benefit those using public transportation.
  • Governance. How do a company’s financial and human capital policies promote a better world? This could include diversity initiatives and transparent compensation policies.

The theory behind ESG investing is that poor E, S or G practices translate to increased long-term risk. For example, a company generating excessive pollution may face future environmental fines. Likewise, a business that doesn’t treat its employees well could face strikes or lawsuits.

Sustainable investing

“Sustainable” isn’t a term just for the food industry. When you become a sustainable investor, you’re looking for companies with sustainable business practices across the board.

Companies with sustainable business practices report economic, environmental and social performance to investors. These companies recognize that people, the planet and profit are all connected. They also know that pursuing only one of these three goals puts the other two at risk.

Companies devoted to sustainable business practices often have mission statements that clearly outline their approach to these three critical factors. They may also release annual sustainability reports to inform investors of their progress.

Can you still make money with ethical investments?

Ethical investors don’t have to trade values for performance. Research shows that sustainable investments provide returns that are competitive with the market — and sometimes better.

For example, 57% of the 116 ESG indexes tracked by Morningstar outperformed their non-ESG peers in 2021. Additionally, roughly 80% of the ESG indexes with five-year histories outperformed the broader market.

Other studies have been less favorable to ESG investments but still positive. For example, research by Vanguard found that while ESG funds didn’t outperform, they also didn’t underperform. This suggests that even if you don’t earn higher returns from ethical investing, it won’t hurt your returns.

However, there are times when sustainable investments truly shine. For instance, Morningstar found that three out of four sustainable equity funds outperformed their category average in 2020 when the COVID-19 pandemic set in. Also, 25 out of 26 ESG equity indexes beat their non-ESG counterparts.

How to find ethical investment options

Before you begin your ethical investing journey, you have to define what’s “ethical” to you. Once you have that detail worked out, you have a roadmap that will help you compare different investment options to build your ideal portfolio.

Single stocks

It’s generally easy to find companies that align with ethical investing principles because they actively broadcast their commitments. You can evaluate individual stocks by:

  • Visiting their investor relations web page. Here, you can often find annual reports that relate to ethical investing principles.
  • Checking key reports. You can see how friendly employers are to diversity and inclusion initiatives through annual “best places to work” lists and the Human Rights Campaign (HRC) Corporate Equality Index.
  • Diving into employee feedback. Sites like Glassdoor host anonymous feedback from current and previous employees.
  • Researching their ESG score. Sites like MCSI and Sustainalytics offer public ESG scores for thousands of companies.

ESG funds and other ethical investment funds

No matter which online broker you use, you can choose various ESG and impact mutual funds and exchange-traded funds (ETFs). To find these funds, you can search for the following keywords in your broker’s ETF or mutual fund screener:

  • ESG
  • Socially responsible
  • Impact
  • Sustainable or sustainability

Some screeners also let you check a category for “socially responsible” or a similar term, too.

Robo-advisors

The list of robo-advisors with socially responsible investing (SRI) options keeps growing. We’ve rated the best robo-advisors on the availability of ethical investments and more. For example, Ellevest offers impact portfolios. Other robo-advisors like Betterment and Wealthfront also give you impact and socially responsible portfolios as options.

Your financial advisor

Never discount the impact a financial advisor could have on your ethical investment goals. A wide variety of firms actively promote their commitments to SRI and ESG principles. Additionally, a financial advisor can do the heavy lifting for you by helping identify and suggest investments that align with your unique values.

The “Find a Financial Advisor” links contained in this article will direct you to webpages devoted to MagnifyMoney Advisor (“MMA”). After completing a brief questionnaire, you will be matched with certain financial advisers who participate in MMA’s referral program, which may or may not include the investment advisers discussed.