Understanding the promises and limits of ethical investing : Life Kit (2024)

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Luisa Jung for NPR

Luisa Jung for NPR

Maybe you want to put your dollars toward fighting climate change, or fighting racism or inequity in the workplace. Ethical investing is one way to do that.

"The broad idea behind this style of investing is a belief that you can generate meaningful, measurable, societal outcomes while also generating a healthy profit," says Manisha Thakor, a financial planner and consultant.

Sounds great right? Invest in companies with good values and still retire comfortably? But as any moral philosopher or fan of The Good Place will tell you, ethics – and ethical investing – is complicated.

"Ethical investing is a lot like love," says Thakor. "Everybody has sort of their own definition and take on it."

The approach to ethical investing even looks a little bit like dating. Think about what you and your partner (AKA investment) should see eye-to-eye on – is it ideas about gender or race or environment? In love and investing, it's important to remember that we're not looking for perfection – but something that feels like a good fit.

Learn the ABCs of ESGs.

The first thing to know when you're starting to think about ethical investing is the acronym ESG, which stands for environmental, social and governance. Thakor says there isn't definitive criteria but gives a loose definition for each:

E - Environmental: "includes things like a company's use of energy, the way they deal with waste pollution, treatment of animals."

S - Social: deals issues like gender, diversity and inclusion. It could also consider a company's charitable donations, contributions to the local community and worker conditions.

G - Governance: generally means that "companies are avoiding conflicts of interest, not engaging in illegal practices and really being transparent in their accounting methods."

Some other terms that you might hear used interchangeably are: Mission related investments (MRIs), impact funds or impact investing, socially responsible investing or sustainable investing.

Determine your values and priorities.

"The first thing that you need to decide," says Thakor, "is what are the causes that you are really trying to make an emphasis and impact on with your dollars?"

Some investments are more straightforward than others. Let's say you're interested in putting your money in a fund that focuses on clean energy. Thakor says, that's a tricky one because there's a debate about whether or not nuclear energy is a form of clean energy.

"You really have to pull back the wrapper and see what is the specific mandate ... the specific investment strategy."

Where do you want to invest that hard-earned money?

Unless you've got a really large sum of money, "the shortest answer is to use a low-cost mutual fund or ETF (exchange-traded fund) that either focuses on a single issue that you believe in passionately, or that has a broad, broad focus," says Thakor.

A fund that has a broad focus means you'll have less control over the specific funds "but generally speaking, ... is focused on companies that are trying to make sure that their next step forward is closer towards making the world a better place."

In picking a fund, she says "take a look at the investment fee. I like to see a fee of no higher than a half a percent on mutual funds and ETFs." Those fees can really add up over the years!

If you, like many Americans, do most of your investing in your workplace retirement account, Thakor says to check to see if your retirement plan includes ethical investment options.

"If you have an option within your workplace employment plan, that's going to be the best place to start off because it's been vetted by your company."

Employers have a fiduciary obligation to choose financially sound options for their employees retirement accounts. Because some of these ESG funds don't have long track records, Thakor says, employers may be reluctant to add them to their retirement offerings.

"I would expect within the next couple of years that will change," Thakor says. "Then we're going to see an explosion of assets coming into ESG."

If your company doesn't currently offer this, Thakor says, send an email to your human resources department and express an interest in socially responsible investment options for your 401k or 403b. You can also ask them what the procedure is for adding new options to the plan or what would need to happen to get a wider range of options.

If you have an I.R.A. account, you can choose what to invest in.

"I am personally a fan of starting with low-cost firms like a Vanguard, or a Fidelity, or a Schwab or a Putnam that have strong names over the long-run," says Thakor.

Make sure you're set up for financial success.

The question of whether or not ESG funds offer the same level of returns as other funds, Thakor says, is hotly debated. "It's not an easy question to answer because there are now so many different types of ethical investments."

But she says, "if you are using the broad approach, in an indexed manner, you are diversifying your risk dramatically."

One way to make sure you're making a financially sound decision is to bust out that calculator. (There are also specific budgeting or retirement calculators available online.) Figure out how much you'll need to make in returns on that investment in order to retire comfortably. "Then you can see, did my ethical investments exceed or fall below that return?" says Thakor.

But, you'll want to consider the bigger, long-term picture. "There's a lot of divergence in returns over a one year period, three year period, five year period. It's not until you get to a 10+ year period you start to really get a sense of where the return is converging to," she says.

Set your expectations and understand the limits of this fledgling industry.

The financial industry, she says, has taken some time to catch up with the idea of connecting morals and money.

To return to our love analogy from earlier, ethical investing is imperfect. It's a little like online dating, where the picture of the person you swiped right on and the person who shows up to the in-person date – look a little different.

"I've had individuals look at the holdings in a specific ESG fund and say, 'Oh my God, there's Exxon in here. I don't want Exxon in here.' But it happened to be that Exxon was rating really well on its ... diversity and inclusion policies and so because that was one of the weighting criteria in the fund, the fund came in on that element."

Thakor urges patience to those who are frustrated with the limitations. "We are in the early days," she says. "Enough people are interested in it that I think we're going to have some very creative solutions."

Is ethical investing really possible?

"There are some people who say the whole idea of ethical investing is a farce," says Thakor. "It's just something we've done to make ourselves feel better after we've ruined the planet. And I think there's some validity to that argument."

But Thakor believes that increased demand for socially responsible investments will lead to changes in the way companies do business.

"If you're in your 50s like me, I don't think we're going to see a dramatic, pinpointable action," she says. "But I think we're going to be able to feel really good that we were part of the generation that started pushing that boulder up the hill."

If you'd like to learn more about ethical investing, Manisha Thakor recommends GreenMoney Journal.

Editor's note: Fidelity and Schwab are among NPR's financial supporters.

The podcast portion of this story was produced by Andee Tagle.

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