5 Things to Understand About Ethical Investing Before Getting Started

Ethical investing is an investment approach where you select investments based on ethical principles. Learn five things about ethical investing including how you define ethical and how to spot greenwashing.

Laura Whateley Published on 07 April 2021.
5 Things to Understand About Ethical Investing Before Getting Started

Ethical investing allows you to make money on the stock market without sacrificing your own principles. It can, however, be a confusing sector for the uninitiated.

If you’re interested in ethical investing, here are some things to consider before you get started.

You need to define what “ethical” means to you

The market for ethical and sustainable investing is still relatively new and there are as yet no global standards or ESG (environmental, social and governance) criteria for what makes a company ‘good’ or ‘bad’.

This means that you need to work out what is most important to you. Do you want to screen out companies in sectors that are damaging the environment or invest in one that is trying to make a difference? Or do you value diversity and inclusion of a workforce above the products and services that a company provides?

Some fund managers, bearing ethical considerations in mind, will decide to invest in companies that have nothing to do with, for example, climate change but who have, say, impressive emissions targets, such as fashion or tech brands. Others will still invest in oil companies that have introduced measures to reduce their impact, or a car manufacturer that is developing a new electric model.

Don’t assume that someone else’s definition of ethical, environmental or sustainable will be the same as yours. Everybody’s priorities will be different – the trick is to find a fund that reflects your views as closely as possible.

Watch out for greenwashing

The lack of global and objective criteria or standards for what or who can call themselves ‘ethical’ means there are some vague definitions out there, and greenwashing can be a problem – meaning that there is a lot of talk about the issues but little actually being done.

Some funds may be badged up as ESG compliant but they may be a long way from what you’d consider ethical, like a company that scores highly on its recycling policy but has other practices that would concern you.

When looking at an ethical fund, examine what its top holdings are. You can find this information in its fund fact sheet. Also, see how many ethical offerings the asset manager has. Is there just one, token option? Or do they consider ESG as a priority throughout their holdings and the companies they select?

When you are looking at individual companies try downloading the company’s annual report to shareholders to see if ESG and sustainability is something the company values.

Past performance doesn’t mean future returns are guaranteed.

There has been a lot of hype about how well ethical and sustainable funds have performed over the past few years, in many cases delivering better returns than those funds that don’t consider ESG criteria.

However, when it comes to investment, just because a company or fund has performed well in the past does not mean that they are guaranteed to do so forever, or even next year.

Keep this in mind when you compare funds on investment platforms. Past performance can be a useful indicator, but is not the be-all and end-all. Look for funds that have performed consistently better than others in their peer group over a number of years, not just the past 12 months. It can also be helpful to see how they fared during difficult years.

Invest ethically for the long term, and diversify

Investing ethically might not be a risky strategy in itself but that doesn’t necessarily mean the companies where your money is invested are low risk, and you should never ignore the golden investment rules.

» MORE: 8 Investments Tips to Think About Before You Invest

This means investing in stocks and shares for the medium to long term; at least five to 10 years. You should consider spreading your investments across different sectors, countries or types of companies as well – never put all your eggs in one basket.

» MORE: What is Diversification?

Also, look at the fees. Some funds charge more for ethical or ESG investment given the extra monitoring and research that it requires, but fees can eat into returns so make sure you examine how much it will cost you over the years.

Don’t forget your pension

Many people don’t realise they are investing through their pension. Auto-enrolment means that almost all of those with an employer are in their company pension automatically.

Have you thought about where it might be invested? Speak to your employer or the provider of your workplace pension. They may have an ethical pension fund available. If they don’t, ask why.

WARNING: We cannot tell you if any form of investing is right for you. Depending on your choice of investment your capital can be at risk and you may get back less than originally paid in.

Image Source: Getty Images

About the author:

Laura is a journalist and author, writing about money since 2008. Including writing for The Times for 9 years. She believes finance doesn't need to be complicated. Author of Money: a user's guide. Read more

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