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Ethical Investing and Socially Responsible Investing: Where to Begin

Wednesday, October 17, 2007

Ethical Investing and Socially Responsible Investing: Where to Begin

Ethical Investing and Socially Responsible Investing

Ethical Investing and Socially Responsible Investing tend to be used by investors interchangeably.

So what exactly is Ethical Investing and Socially Responsible Investing?

Before discussing Ethical Investing you must first have a basic understanding of Investment in general.

Investment can be though of as placing discretionary funds (money that is left over after paying all expenses) to work with the anticipation of use at some point in the future. In return for saving those funds today, an investor requires compensation.

When determining how an investor would like to be compensated they will need to consider two elements simultaneously: risk and reward.

Risk refers to the amount of risk investors are prepared to take in order to receive a certain return. A very basic definition of risk would be the probability of a successful outcome investors may assign to a certain investment, generally, the greater the uncertainties the greater the risk. To determine what investments are right from a riskiness perspective an investor will need to consider the following: Are you risk averse (don’t want risk)? Risk neutral (willing to take on a degree of risk in order to receive a greater return)? Or Risk loving (willing to take large risks with the potential of receiving larger returns)?

Reward is the desired amount you would like to receive from an investment. Risk and Reward tend to be correlated very strongly—as the potential reward increases so does the potential risks.

Ethical Investors just throw a third variable into the mix: Responsibility.

Responsibility can mean different things to different people. This is a variable Taylor made to individual preferences; however, a generic definition is the way that a corporation conducts its business: Is there goal to increase profits or leave the world a better place?

For example, an investor who deems investing in weapons or cigarettes to be unethical would not invest in a company that produces either because they believe it irresponsible.

To determine what a company invests in and to what degree you will consider a company unethical can take some detective work. You will need to ask yourself questions like: would I invest in a company that supplies companies involved in what I deem as unethical and will I invest in companies that buy products from companies I deem as unethical.

For example: Would I be willing to invest in a mining company that sells iron to a weapons manufacturer who will turn this raw material into a weapon. Or would I invest in a company that buys paper from a company that also makes cigarettes. Another concern would be whether an investor would consider investing in a company that produces alcohol for example but donates to an AA Group to help alcoholics with their problems.

Combining these three variables you get the 3 R’s of Ethical Investing: Risk, Reward and Responsibility. The degree to which you incorporate each variable and the significance of each in your investment decisions will guide your investment strategy.

Some valuable resources for ethical investing include:

Ethical Funds
Social Funds

Socially Responsible Investing
Corporate Socially Responsible News Wire

Just remember when engaging in Socially Responsible Investing or Ethical Investing personal choice is key to the Responsibility Variable while the goal is still to maximize profits while minimizing risk. Also, it has been displayed over the past 20 years that many investments deemed socially responsible have outperformed peers and this may be a direct result of management at many companies adhering to higher standards.

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