An investment strategy where the investor’s ethical values are the primary objective, along with good returns
Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more. Start with a free account to explore 20+ always-free courses and hundreds of finance templates and cheat sheets.
Written byCFI Team
What is Ethical Investing?
Ethical investing is an investment strategy where the investor’s ethical values (moral, religious, social) are the primary objective, along with good returns. With suspicious and illegal investment deals on the rise, many investors are starting to insist that companies they invest in are socially responsible. This means treating their employees with respect, creating healthy products, and services and keeping away from unethical business practices.
Who Will Ethically Invest?
Ethical investing is for investors who want to invest their money for noble causes. For example, if an investor thinks that tobacco is unhealthy, then they would avoid companies that produce tobacco or own investments in tobacco-manufacturing companies.
Types of Ethical Investments
1. Socially Responsible Investing Funds (SRI Funds)
SRI funds avoid investing in controversial areas such as gambling, firearms, tobacco, alcohol, and oil. Here, the investor’s moral value is given critical importance in investment selection.
2. Environmental, Social and Governance Funds (ESG Funds)
Unlike SRI funds, ESG funds consider in their decision-making how environment, social and governance risks and opportunities can cause material impacts on a company’s performance. They can invest in sustainability while maintaining the same level of returns as they would with a standard approach.
3. Impact Funds
Impact funds place equal importance on fund performance. Hence, they aggressively look at creating ethical changes supporting companies that provide certain products and services. Impact funds are suitable for investors who are socially responsible but also want good returns.
4. Faith-based Funds
Faith-based funds only invest in stocks that follow religious values and ideals, and strictly exclude investments that don’t fit the category.
Advantages of Ethical Investing
- The investor feels happy when an ethical holding company performs well. They benefit emotionally and financially when the company shares their values.
- As more people invest in ethical funds, the investments can grow substantially in the future.
- Since ethical investing is gaining importance, it will encourage other businesses to improve their ethical practices to attract funding.
Disadvantages of Ethical Investing
- As ethical investing is not a passive strategy, it involves a lot of research to ensure that it aligns with the investor’s values and beliefs.
- Ethical investing may not provide optimal returns; hence, the investor sacrifices financial gains for an ethical approach
- The fees for ethical investing can be higher due to the research involved in identifying the right investment.
Does Ethical Investing Work?
One key aim of ethical investors is to avoid investing in companies that produce products that are against the social, moral, and religious values of the investor. However, boycotting an evil company by not investing in it doesn’t mean that money is not going to the company.
When an investor purchases a stock, the money goes to the seller of the stock, who is an individual investor and not the company. The company only makes money when it issues new stocks like an initial public offering (IPO). Hence, ethical investors are not punishing the evil companies.
Also, by boycotting a company, ethical investors are reducing the pool of potential shareholders which may reduce the price of the stocks, this only makes it more attractive to unethical investors in the market to buy the stock at these lower prices.
Ethical investing is beneficial to society; however, it needs to fulfill certain elements that are high standards to achieve.
- A successful business idea needs to be identified, which will help the world. For example, solar panels are good examples of ethical investing. However, a funding solar panel company that pollutes the environment through its manufacturing process is self-defeating.
- If the investor is able to identify a business opportunity that will result in a positive impact on the planet, then there needs to be “additionality” – a path by which the business can lead the company to grow sustainably. However, it is difficult to achieve such an objective in the stock market.
- Not investing in unethical companies doesn’t mean they will disappear, in fact they may continue to flourish as other investors seeking high returns will always be available.
Should Investors Stop Ethical Investing?
Ethical investing isn’t a bad thing. It does help companies gain access to capital to grow and fund their CSR (corporate social responsibility) programs. It also gives investors the ability to influence businesses operations and practices towards their personal values and ethics. .
This sometimes comes at a cost of lower financial returns on their portfolio, but the trade off for other benefits makes it worthwhile.
Conclusion
An investor chooses to ethically invest when they want to make a difference in society. Their primary goal from the investment is to meet their moral, social, and religious values, while returns are secondary.
While ethical investing is good, it is an expensive strategy, as thorough research needs to be done to find investments that meet the investor’s primary goal. Also, boycotting investment in unethical companies will not prevent them from continuing to succeed as other investors seeking returns will support them.
More Resources
CFI is the official provider of the global Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional CFI resources below will be useful:
