What Is Ethical Investing? (2024)

Investing solely to benefit from the highest possible returns is becoming somewhat passé. Today, more and more investors are focused on choosing assets that not only deliver great returns, but also help remedy environmental and socially conscious issues.

A 2022 Stamford University study found that 70% of investors between the ages of 18 and 41 said they were very concerned about environmental issues. By contrast, just 35% of investors in older cohorts said the same thing.

Even more compelling is that younger investors told researchers that they were willing to sacrifice returns for the chance to invest in ethically and socially conscious companies. This is the core of what’s meant by ethical investing.

What Is Ethical Investing?

Ethical investing generally means investing in companies whose products and business practices match your personal beliefs. However, there is no one, universally-accepted definition for this concept.

In the past, ethical investing was a niche practice that was particularly used by investors in religious groups that only wanted to invest in stocks that aligned with their values and faith. Typically, that meant avoiding companies involved in industries related to gambling or alcohol.

Since then, the concept of ethical investing has evolved and exploded in popularity. Today, investors—particularly younger investors—want to ensure their investments align with their values. They want their money to support ethically and socially conscious business practices.

Rather than using ethical investing as a way to decide which companies not to invest in, ethical investing is now a more proactive strategy where investors seek out companies making a difference. For example, investors may look for companies focused on clean energy or that ensure fair labor practices.

Types of Ethical Investment Funds

Ethical investing is a broad term used to describe different approaches to investing. It can be broken down into four main categories:

• Socially Responsible Investing: SRI investing avoids controversial industries like gambling, firearms, tobacco, alcohol and oil.
• Environmental, Social and Governance: With ESG investing, investors consider the environmental and social impacts of the company and its governance. Investors tend to focus on sustainability and transparent business practices.
• Impact Investing: Impact investing combines social or environmental benefits with financial returns. It’s best for investors who select companies based on their performance in those areas and deliver growth at the same time. For example, impact investors may seek out companies that produce solar energy systems.
• Faith-Based Investing: Faith-based investors only invest in companies that follow their religious values, and they exclude companies that don’t match that belief system.

SRI vs. ESG Investing

Although the categories of ethical investing share common approaches, such as adherence to ethical standards rather than financial concerns, there are important differences between them.

First off, while SRI investing tends to avoid certain companies, ESG investing makes a conscious decision to invest in certain companies. This means that SRI investing is a decision not to endorse specific industries or business practices, while ESG investing is a positive decision to choose certain investments based on the investors own ethical considerations.

ESG investing is a more proactive approach, since it’s actively choosing companies rather than merely avoiding companies.

Impact investing, on the other hand, can use either SRI or ESG factors to build a portfolio that could bring an investor outsized returns.

Faith-based investing does not have to adhere to either SRI or ESG concerns, although it could take those into consideration. It might also operate as a form of impact investing. However, rather than choosing investment options based on secular factors, a faith-based portfolio is decided upon solely by the religious values of the individual investor or organization.

How to Develop an Ethical Investment Portfolio

If you want to invest in ethically and socially responsible companies, you can build a portfolio on your own by investing in individual stocks. But that approach can be time-consuming and expensive.

Another option is to invest in mutual funds and exchange traded funds that only invest in companies that meet environmental, governance or social standards. You can get a diversified portfolio with just one investment and get exposure to a variety of companies.

How Do Ethical Investing Portfolios Perform?

How does ethical investing affect your returns? Surprisingly, you may not have to sacrifice returns to invest in companies that align with your values.

We compared the performance of two index funds over the past three years, one which is socially responsible and the other which tracks the broader market:

• iShares ESG Screened S&P 500 ETF (XVV): This socially responsible ETF launched in September 2020. It invests in companies that are part of the , but it screens for ones that could be controversial and excludes those. Its price at inception (September 2020) was $25.58, and it increased to $31.76 by the end of May 2023. That’s a 24.16% increase over the course of 2.5 years, which means if you had invested $1,000 in XVV at the start of that time, your investment would be worth $1,241.60 by the end of the period.
• iShares S&P 500 Index Fund (WFSPX): Unlike XVV, this index fund tracks the performance of the entire S&P 500. The price of this fund increased from $396.14 in September 2020 to $491.24 in May 2023. If you had invested $1,000 in this fund in 2020, you’d have a 24.00% return 2.5 years later, worth $1,240.00.

This means that from September 2020 until May 2023, iShares’ S&P 500 ethical investment fund slightly outperformed the broader S&P 500 by about 0.16%.

Advantages of Ethical Investing

• It may improve your personal satisfaction. When you only invest in companies whose missions you support, you may find that you have a higher level of satisfaction from your investments since you’re supporting causes you believe in.
• It allows you to support companies instituting change. By investing in ethically or socially responsible companies, you back companies that are making a difference in areas important to you.
• It may pressure other companies to follow suit. If more people choose to invest in ethically and socially responsible companies, other companies may have to adapt their own practices to compete.

Disadvantages of Ethical Investing

• Designing a portfolio can be time consuming. Ethical investing requires more research than other investing strategies. If you build a portfolio on your own, you have to research each company’s mission and business practices and adjust the portfolio’s holdings accordingly.
• Your portfolio may underperform the market. Although some investors are willing to accept lower returns for ethically responsible investments, not everyone feels that way. Your portfolio may underperform the market, affecting your returns.
• You may have to pay higher fees. Because of the additional time and research it takes to manage ethically and socially responsible funds, investment companies typically charge higher fees.