How to choose the right ethical investment for you
Choosing how and where to invest your money is a personal decision which depends on your own goals and circumstances, attitude to risk and personal beliefs.
There is a lot of information available online to help you start- though less so for ethical investing. Our website covers the main areas of where to invest: in Cash, tax- efficient wrappers such as ISAs and Pensions (which typically are invested via funds), and the different options for Direct Investment.
However, what should you consider when looking at choosing investments in these areas? Below we outline some of the main financial and ethical issues to consider.
How much risk are you willing to take? Risk takes 2 broad forms:
Absolute risk: The risk of losing some, or all, of your investment permanently.
Investing directly into small, unproven companies has a high chance of you losing some- or maybe all- of your capital (though can come with high rewards). Contrastingly, putting your money into cash accounts has a very low chance of declining in absolute value.
Volatility: How volatile the returns of your investment are.
Some investments- such as most funds- don't often lose some or all of their capital permanently, but fall and rise in value over time. More volatile investments include things like Emerging Market equities, while less volatile include highly rated government bonds.
>>> Exposure to certain countries/ sectors
As outlined, certain investment types carry more risk- but potentially higher returns- than others. You may have opinions on specific sectors or countries that you do or don't want exposure to, either from a risk or a potential returns perspective. Technology companies, on the whole, are much more growth orientated and volatile than Utilities, for example.
Studies have shown that, over the long term, fees are one of the biggest determinants to an investment's performance. The main factor that decides the level of fees is whether the investment is active or passive, described below:
Active investment management involves paying a professional to choose investments on your behalf. When investing into a fund, this will involve the fund manager researching and choosing what stocks to include.
In theory, you are paying active managers for their stock- picking skill which in turn should result in higher returns for you.
Passive investment management involves choosing an index of companies to invest into. There are many, many different indexes covering different countries and sectors. An index has a set of pre-defined rules, which if a company meets allows it into the index. There is therefore no stock- picking involved from a professional fund manager.
As such, passive funds have cheaper fees than active funds. While in theory active funds should result in higher returns, in practice passive funds have generally outperformed their active counterparts.
>>> What matters to you?
Most investments do not explicitly take ethical decisions into account when choosing what companies to invest into. However, a number of funds and other investments now exist which explicitly address certain ethical, environmental or socially conscious issues.
A good way to visualise what types of investment there are from an ethical perspective is the 'Spectrum of Impact'.
The goal is to avoid companies which cause significant environmental or social harm within your portfolio.
This can exclude entire sectors (such as tobacco or weapons) or specific companies (which is less common) based your own moral or ethical beliefs. All companies in responsible investment funds will review the environmental, social and governance (ESG) aspects of each company.
The goal is to invest into companies which have positive effects for society and the planet.
Companies that meet this criteria will have better environmental and social records than many of their peers.
The goal is for your investments to have a significant contribution towards problems faced by the planet or society, for example in climate change or for people in poverty.
Companies will be those whose main operations are in achieving solutions in order to benefit society and the environment over the long term.
>>> Avoiding Specific Companies, Countries or Sectors
Many ethical funds avoid investing into entire sectors such as tobacco, weapons and gambling. This is fairly common place for responsible investors and can be found by reviewing the fund's investment philosophy. You can view more information on ethical funds through our Fund Finder.
Some responsible funds also avoid entire countries, such as those that are under certain trade embargoes. In practice, however, these have a limited effect with what investments are held, as most stocks in most funds are listed within a limited number of countries.
If you feel particularly strongly about avoiding a particular company, details of this are hard to come by. Most funds report their ten largest holdings- it's best to look at this to see if the company is in there- if it isn't, then exposure to the company, if it exists, will at least be small. However, most funds don't usually outline all the stocks that they own, so it can be difficult to be totally confident that a particular company is avoided. Our Fund Finder outlines details of certain ethical funds, as well as links to where you can find more information- such as stocks owned.
>>> Active v Passive
In addition to the financial considerations of active and passive fund management, there are also ethical issues which are important to give thought to when choosing an investment:
Passive: as mentioned earlier, passive investments track an index that has a set of pre- defined rules. Passive funds with responsible investment criteria typically screen companies on environmental, social and governance (ESG) issues, and allow those that pass the screen into the fund.
This screen is almost always done robotically, meaning that the result is very black or white- either the company gets a certain score and is in the fund or not. This is why some companies that you may not think are all too ethical end up in a passive responsible fund.
Active: The managers of active funds, in theory, are much more hands- on with their portfolio companies. They research into each company and understand the environmental and social components of each and can argue why they should be in their fund.
If you choose a good active ethical fund manager, they will use their influence as shareholders to try and influence company management to incorporate more sustainable decisions.