Every Wednesday, we publish our “Investor Toolkit” series on TSI Network. Whether you’re a beginning or experienced investor, these weekly updates are designed to give you advice on specific investment topics. Each Investor Toolkit update gives you a fundamental piece of investing strategy, and shows you how you can put it into practice right away.

Today’s tip: “Ethical or socially responsible investing can be a misleading concept. Often it’s an oversimplified reaction to a complex situation, having little impact on the companies targeted while limiting perfectly good investment opportunities.”

From time to time, we are asked about ethical investing (or “socially responsible investing”). I’d say it works as a marketing angle for a handful of small investment companies, and it may make you feel better about your investments. But it won’t do much to improve your investment results, or cut down on what you see as unethical corporate behaviour.

If you refuse to invest in an ethically questionable company, you don’t hurt the company. But you do help others who are willing to invest in the company, because they get to buy it a little cheaper.

We, of course, avoid companies that may be breaking the law, or doing anything that’s likely to get them sued in any meaningful way. That’s not just ethical investing—it’s also successful investing. Companies that would cheat or harm their employees or the public may also feel free to abuse their stockholders.

However, it’s all too easy to treat distaste with a perfectly legal activity as an ethical question, even when it’s more of a political disagreement.

For instance, we happily follow the instructions of portfolio management clients who insist that we refrain from investing their funds in tobacco stocks. We share their distaste with smoking. I haven’t recommended a tobacco stock in decades. However, I wouldn’t support, for instance, government bans on tobacco. That would simply create a new type of black market for criminals to exploit, just as they now exploit demand for illegal drugs.

Discouraging or banning distasteful activities can lead to far more harmful consequences. For instance, some ethical investors refuse to invest in companies that charge high interest rates on “payday loans” that they make to low-income working people. They see the practice as abusive and feel it should be banned. But doing so could steer the business back to cash-only loan sharks, who traditionally charge 20% interest (“six for five”) per week.
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What is a worthwhile trade-off?

Banning oil production from the oil sands could protect the environment in remote parts of Canada. Canada has far stricter environmental laws than most other oil producers, however, and Canadian oil profits are unlikely to wind up financing terrorism.

More important, world oil supplies have to come from somewhere. Otherwise, oil prices will go up enough to cut into economic growth. Some investors think that’s a worthwhile trade-off. However, economic slowdowns and setbacks are hardest on those at the bottom of the income scale.

If you want your investing to help the environment, or support some ethical or socially desirable cause, it’s more effective to follow our three-part strategy. That is, invest in well-established companies; spread your money out across the five main economic sectors; and downplay or avoid stocks that are in the broker/media limelight (and thus subject to excess investor expectations).

This should enhance your investment returns. That way you’ll have more profits to share with charities that directly support your favourite causes.

COMMENTS PLEASE—Share your investment knowledge and opinions with fellow TSINetwork.ca members

Do you refuse to invest in any products or companies you believe to be unethical? Could anything make you look more favourably on these companies?