Ethical investing, sometimes referred to as socially responsible investing, is becoming a more popular consideration among investors. The idea is to deliberately invest in companies or industries that are bringing about a positive social change, such as renewable energy companies, while minimizing investments in destructive or non-progressive entities. For example, if a company is exposed to or have engaged in discriminatory hiring practices, you may choose not to invest in it, or if a company is “going green,” you may be incentivized to invest in it more.
The concept sounds appealing, but is it a viable long-term investing strategy?
The Problems With Ethical Investing
Let’s start by identifying some key problems with this approach:
- Ethics aren’t inherently tied to a company (or industry). Investing in equities normally involves enlisting the services of a financial services company and/or insurance broker with the right licenses (Series 6 or Series 7). Just because a company seems to engage in ethical practices doesn’t mean its insurance agents or financial advisors are inherently ethical. People have the power to make decisions within an organization that differ from the company’s core philosophy. You can attempt to get around this by studying the individual leaders within each organization, and the companies within each industry, but the effort may not be worth it.
- The visibility of ethics. It’s hard to make a realistic evaluation of a company or industry’s ethics based on publicly available information. Ethics is, after all, “what you do when nobody’s watching.” For example, a company might put out dozens of press releases stating how committed its company is to maintaining transparency, but in reality, the CEO is withholding important information about the company’s performance. For example, it was many years before Enron was revealed to have been engaging in accounting fraud.
- Detraction from the bottom line. If your end goal is to make as much money as possible from your investments, making ethical decisions may not help you. In many cases, socially responsible efforts—like installing clean energy solutions or donating resources to charitable organizations—can actually detract from a company’s profitability. This will vary, but in general, making purely ethical decisions can’t guarantee you a consistent (or positive) rate of return.
- Subjective reasoning. It’s also important to remember that ethics are subjective. What matters to you may not matter to other investors, and what you think is best for the country may not necessarily be. This doesn’t preclude you from investing in the companies you personally think are ethical, but it raises problems for the general concept of “ethical investing.”
The Bright Side
There are, however, some bright sides for the strategy:
- Group effects. Ethical practices can drive buying decisions; for example, the millennial generation increasingly wants to purchase ethically sourced products. If a company’s ethical practices allow it to attract a greater percentage of its target market than a competitor, its stock price is going to benefit. Accordingly, you can use ethical investing as a strategy in markets or industries you feel would benefit from their inherent ethics. This is difficult to predict, especially as demographic preferences change, but may be viable.
- Scandal mitigation. Any ethical scandal has the power to significantly drop a stock’s price. It could be the revelation of discriminatory practices, an accusation of insider trading, privacy concerns for users, or an environmental disaster. By investing in ethical companies, you can mitigate the risk of suffering a stock price drop at the announcement of such a scandal. Of course, it’s hard to see what’s going on behind closed doors, so you might be as surprised as everyone else when a revelation emerges.
- Investing for more than a profit. We also need to consider the possibility of investing for more than just a profit. While the majority of investors trade stocks as a way to build wealth or save for retirement, others may use investing as a way to exert some measure of control over the direction of the market; for example, they may be able to use their position to vote in company elections, or subtly drive the popularity of businesses they feel are operating in consumers’ best interests. In this way, ethical investors stand to benefit in ways other than direct monetary gain.
So is ethical investing the right approach? If you only choose companies or industries with a solid ethical foundation, you might limit your returns. But if you’re looking to get more out of your investments than a predictable stream of profitability, it may be the right decision for you. Otherwise, ethics should be one of many considerations when building your portfolio; for the average investor, ethical or socially responsible considerations shouldn’t make or break an asset’s viability.
