Ethical Investing: Benefits And Drawbacks Of Ethical Investing

By Amy Fontinelle

There are many reasons to pursue ethical investing - and many reasons why people avoid it. Here, we take a closer look at their motivations.

The Feel-Good Factor
Ethical investing certainly has a large emotional component. People who choose to follow an ethical investing strategy let their feelings, about how workers should be treated, how the natural environment should be cared for, how corporations should treat their shareholders and so on drive their investment decisions. One of the benefits of this style of investing, is the potential for good feelings when a company, whose actions you support, performs well financially, bringing good returns to your portfolio, and benefits to all of its stakeholders.

The downside of this emotional component is that if a company violates one of the principles you thought it stood for, can bring massive feelings of disappointment. The same thing can happen if the company's principled stance fails to bring good financial returns, or even brings financial losses.

Compounding the Effects of Everyday Choices
If you already live your life in strict accordance with a particular belief system, ethical investing is a logical addition to that system. The decisions that large corporations make have a much bigger impact than the decisions that one person makes, after all. It doesn't make a lot of sense to ride your bike everywhere, and only use canvas bags for your groceries while holding shares in a company with a poor environmental record. Of course, if you're an average investor with a few shares, or even a couple hundred shares, you're too small to have much influence on a company, but you'll probably sleep better at night knowing that your investment choices are aligned with your living principles.

Deciding Where to Draw the Line
It can be difficult to find investments that perfectly meet your criteria, which means that you have to decide what's most important for you and where, if anywhere, you're willing to compromise. What if 5% of a company's operations involve something you don't approve of, and the other 95% in something you do? Do you invest? What if you like a particular company, but you don't like its parent? What if you invest in a company you support, and then it gets purchased by a company you hate? If you have to choose a lesser evil, why invest at all? What about socially neutral investments - do they have a place in your portfolio? You have to overcome difficult decisions, like these, if you want to be an ethical investor. Not investing isn't an option if you want to be financially successful.

Forgoing High Returns from Investments that Don't Meet Your Criteria
When you screen out investments that don't meet your environmental, social or governance criteria, you'll inevitably be screening out some high performers. You won't necessarily earn lower returns by pursuing an ethical investing strategy, but it will take more work to track down the right investments. (Learn more in The Evolution Of Sinful Investing.)

Expending Time and Effort
Socially responsible investing is not a passive strategy. It takes a lot of time and effort to track down and review all the research you'll need to make your decisions - more time and effort than it would take if you were solely focused on financial performance. Once you've found investments you like, you have to keep tabs on them to make sure they meet the ethical and financial goals you expect them to. Sometimes you'll have to sell investments that fall short and find new ones to replace them. If it all sounds like so much work that you feel totally discouraged from investing at all, you might want to invest conventionally and commit to donating a percentage of your profits to charity.

Overcoming High Fees
If you choose to invest in socially responsible mutual funds, you might have to overcome higher expenses than you would as a conventional investor. Essentially, what you're paying for is to have someone do all the difficult research on ethical and financial performance for you. If you're busy and if you trust the mutual fund company, this price may well be worth it. But high expenses can really drag down your returns, especially over the long run. Will you still be able to meet your financial goals if you're paying expenses of 1.2% annually instead of 0.2%? (For more, check out Stop Paying High Mutual Fund Fees.)

Going Against the Tide
Socially responsible investing is still a small part of the overall market. The majority of investors don't decide what to buy or sell based on the same criteria that socially responsible investors use. Lots of investors don't give much thought about what they invest in - they just choose the options that their 401(k) manager recommends given their anticipated retirement date, or they pick an S&P 500 index fund and forget about it. Once again, you'll have to work harder to find the news and information you'll need to make your investing decisions - you may not be able to find it in conventional financial reporting sources.

Let's assume that you decide to go ahead and invest, according to your principals, and that you're quite successful. You need a plan to dispose of your assets after you die so that they continue to go toward causes you support. We'll discuss estate planning in the next section.