Ethical investing: a fiercely debated topic and growing global investment trend that has piqued the curiosities of those looking for a more world-friendly alternative to traditional investment strategies.
- Ethical investing largely depends on individuals’ ethical and moral views and perspectives.
- Ethical investing performance can fluctuate since there is no guarantee of performance.
- Is a highly personalised approach to managing one’s investments based on their unique ethical considerations.
What is Ethical Investing?
Known alternatively as sustainable investing or socially responsible investing (or SRI for short), ethical investing has recently gained traction as a viable investment strategy for those looking to align their investment portfolio more closely with their personal values. And never has this been more true than in Australia, where a resource-saturated share market has left many potential investors feeling forced to choose between kick-starting their investment portfolio and sacrificing their personal ethical values.
For some, ethical investing might sound like the magic solution to the issue of combining their personal values with their financial goals and investment strategy. But, just like every other investment strategy, ethical investing has both benefits and downsides that can impact on your overall investment return, as well as the likelihood of you achieving your financial goals.
As your team of investment experts, we thought we’d break down the topic of ethical investing and give you everything you need to know to decide whether investing ethically is the right choice for you.
What does “Ethical” mean in ethical investing?
When you think of the word ethical, it’s likely that, depending on who you are and your personal moral framework, your definition of what it is changes. For some, ethical investing is all about not supporting companies that damage the environment, while others only want to invest in companies with ethical manufacturing processes or those selling cruelty-free, sustainable products.
But because the very definition of what is ethical is hard to pin down and subjective, deciding on whether ethical investing is the right option for you will depend on exactly what your definition of ethical is. We believe that the key to a successful investment portfolio is diversification. When your investments are spread across multiple different industries, sectors and countries, you are much better equipped to successfully weather any fluctuations in the share market.
However, through the process of investing ethically you are essentially restricting the number of assets you’re able to invest in. If what you consider to be ethical has broad parameters, your portfolio is still able to be diversified. But if your definition of what is ethical is very narrow, it stands to reason that your investment portfolio will become concentrated in one area and thus more vulnerable to fluctuations in the market.
If you’re concerned about opening yourself up to unnecessary investment risk but would still like to invest ethically, your financial advisor can help you assess which investment options are viable for you and your particular financial goals and risk tolerance.
The Pros of Ethical Investing
While some proponents of more traditional investment strategies may have you believe that the cons of ethical investing far outweigh the pros, there are some definite benefits to ethical investing. These include:
A Lighter Conscience
It may seem like an obvious point, but one of the main benefits of investing ethically is the peace-of-mind it may bring you to know that you’re not inadvertently supporting a business or industry in your financial world that you oppose in other aspects of your life. While you may be sacrificing a few of the other benefits that those of your peers with non-ethical investment portfolios are able to access, such as the potential for larger returns and access to a greater investment diversity, you do gain complete ethical peace-of-mind.
Think of it like this, When buying free-range eggs, opting for fair trade coffee or switching to green energy, you don’t expect a discount over the alternatives. Instead, you make the changes because you’re seeking to have a more positive impact on the world around you.
An ethical investment portfolio works the same way; expect to potentially give up a little performance or pay slightly higher fees but rest easy knowing that your investment portfolio is aligned with your values.
Supporting Companies You Respect
When purchasing a company’s shares, you are – at the crux of it – entering into a partnership with that company. You offer financial support, in the form of the shares purchased, and in return the company works to provide you with a return on your investment through whatever it is that they do best.
When you choose to invest in a company that is ethical, you are giving them the support they need to continue doing the activities or selling the products that interested you in investing in them in the first place.
While donating or purchasing said company’s products may be a more direct way to support them, there’s only so many times the everyday family may be able to afford this. By purchasing shares, you’re ensuring that you continue to work towards achieving your financial goals while simultaneously supporting the work of companies you support ethically.
The Cons of Ethical Investing
We touched on a few of the downsides of ethical investing earlier, but there are a number of cons of ethical investing that require consideration before deciding on whether this strategy is the right one for you. These cons include:
Just like those organic vegetables or cruelty-free beauty products, ethical investment funds often charge a higher fee percentage than their non-ethical counterparts. It pays to keep a close eye on these fees before deciding on which funds or companies to invest in, as they can quickly eat into your investment returns.
In fact, a number of large, well-known ethical brands charge up to 2.5% for ethical investment. When you add the fees that some financial advisors charge on top, you’re already sacrificing a considerable percentage of your investment return every year before you even begin. Luckily not every financial planning firm will charge an investment fee – including My Wealth Solutions – but it’s still important to consider this before making any investment decisions.
Then, when you consider that there’s a chance that your ethical investment portfolio may perform less well than a non-ethical portfolio – due to the restricted nature of the investments inside an ethical investment portfolio – these fees may make the difference between you achieving your financial goals in the timeline you’d like or not.
Just as you would with a non-ethical investment fund, make sure to triple check every asset you’re thinking of investing in with your financial advisor to ensure that you’re not going to be taken by surprise by any hidden fees.
The Risk of Lower Performance
When comparing ethical investing to more traditional investment strategies, one of the first downsides that make the average investor worried about investing ethically is the potential for lower performance, and thus lower returns, than their non-ethical counterparts. Since, when investing ethically, you are restricting the number of assets and industries you’re able to invest in, there’s a chance that if one of these sectors experiences a slow year, your returns will mirror that lack of growth.
But, don’t worry, choosing to invest ethically doesn’t automatically mean that your investment portfolio will perform lower than a non-ethical portfolio. In fact, it’s entirely possible for ethical funds to perform better over the long term, especially if your definition of what is ethical is quite broad and you only cut out a few sectors as a result.
However, if you’re thinking of investing in ethical funds with the idea of outperforming the rest of the market – including non-ethical funds – then it is likely that ethical investing is not the right investment strategy for you. The chance of outperforming the market in any investment strategy is very rare, and the pursuit of achieving it can open you up to unnecessary investment risk. That’s why we believe that the right approach to investing ensures you minimise the risk to your portfolio by diversifying your assets as much as you can.
An investment advisor can work with you to ensure that your investment portfolio is ethical while also making sure that it is suited to your particular financial goals and risk tolerance.
Is Investing Ethically Worth it?
The answer is…it depends!
Whether investing ethically is the right strategy for you will depend on your particular financial circumstances, goals and timeline.
For those who are happy to sacrifice a little performance and potentially pay more in fees than non-ethical investment funds, ethical investing could be the right solution to match your investment portfolio with your personal ethics. But, for those who may have a shorter investment timeline and thus need assets that are more likely to produce higher returns, ethical investing may not be the right option for you.
However, even if you decide to build an investment portfolio that isn’t entirely ethical, there are still ways you can use this portfolio to support the work of those companies and industries that you care about. For example, you could structure your budget in a way that dedicates a portion of your investment returns to donating to those companies or causes you support. This way, while you’re not investing directly in them, you’re still able to support the companies you care about. In fact, some would argue that donating provides a more direct and more meaningful method of supporting the causes that are important to you.
Still worried about whether investing ethically is the right strategy for your particular financial needs? Don’t worry, we can help.
Our team of expert financial advisors is here to help you assess your investment options, whether ethical or not, and decide which strategy is right for you and your unique financial circumstances and goals.
All you have to do to get started is let us know how we can help.