What is ESG Investing? 9 Ethical Principles for Beginners

The question of how to grow wealth while making a positive impact weighs heavily on the minds of many modern investors. You’ve worked hard to build your savings, and now you’re ready to put that money to work – but not at any cost. The nagging question remains: can you grow your wealth while still making a positive impact on the world? This is where responsible investing comes into focus, offering a framework that could potentially satisfy both your financial aspirations and ethical concerns.

The investment landscape has evolved dramatically over the past decade. Gone are the days when profit was the sole consideration for investors. A growing number of people want their money to reflect their beliefs about environmental stewardship, social responsibility and good governance practices. If you’re new to this concept and wondering how to integrate ethics into your investment strategy, you’re not alone.

This article will guide you through exactly what is ESG investing, explaining the fundamental principles that can help you make informed decisions. Whether you’re looking to start small or completely overhaul your portfolio, understanding these nine principles will provide a solid foundation for your journey into the world of responsible investing.

What is ESG Investing?

Environmental social and governance investing, commonly known as ESG investing, is an approach that considers environmental, social and governance factors alongside financial metrics when making investment decisions. Unlike traditional investing models that focus solely on financial returns, ESG investing acknowledges that companies operate within broader societal and environmental contexts that can affect their long-term performance.

The ‘E’ in ESG refers to how a company impacts the natural environment. This includes considerations like carbon emissions, resource usage, waste management and biodiversity protection. Companies with strong environmental practices might invest in renewable energy, implement water conservation measures or develop sustainable products.

The ‘S’ examines how a company manages relationships with its employees, suppliers, customers and the communities where it operates. This encompasses labour practices, diversity and inclusion initiatives, product safety and data privacy.

The ‘G’ looks at how a company is governed. This includes board structure, executive compensation, shareholder rights, corporate ethics and transparency in accounting and tax practices.

ESG investing has gained significant momentum in recent years, with global ESG assets expected to exceed £53 trillion by 2025, representing more than a third of projected total assets under management. This growth reflects a fundamental shift in how investors view the relationship between profit and purpose.

What is ESG investing if not a recognition that financial success and positive impact can coexist? For many beginners, understanding this concept is the first step toward building an investment strategy that aligns with both financial goals and personal values.

The Evolution of Ethical Investing

Before exploring the principles of ESG investing, it’s helpful to understand how we arrived at the current landscape of ethical investment options.

The concept of values-based investing strategies isn’t entirely new. Religious investors have practised forms of ethical investing for centuries, with Quakers and Methodists avoiding investments in slavery and war in the 18th century. The modern movement gained momentum in the 1960s and 1970s, when investors began excluding stocks of companies involved in the Vietnam War or supporting the South African apartheid regime.

Throughout the 1980s and 1990s, the focus shifted toward social impact investment examples that demonstrated how capital could address specific social or environmental challenges. Microlending institutions like Grameen Bank showed that investments could generate both financial returns and positive social outcomes.

The term “ESG” itself was coined in 2004 in a report titled “Who Cares Wins,” which argued that embedding environmental, social and governance factors in capital markets would contribute to more sustainable markets and better outcomes for societies. Since then, the field has expanded dramatically.

Today’s ethical investing landscape includes a spectrum of approaches:

1. Negative screening (excluding harmful industries)
2. Positive screening (seeking out beneficial companies)
3. ESG integration (incorporating ESG factors into financial analysis)
4. Impact investing (directly targeting positive outcomes)
5. Corporate engagement (using shareholder power to influence company behaviour)

Understanding this evolution helps contextualise the current state of sustainable investing vs ESG. While sustainable investing broadly refers to any investment approach that considers environmental or social factors, ESG investing specifically uses the three-pillar framework of environmental, social and governance criteria to evaluate companies.

Nine Ethical Principles for Beginner Investors

Now that we understand the background, let’s explore the nine fundamental principles that can guide beginners in ESG investing. These principles provide a framework for making informed decisions that align with both financial goals and personal values.

1. Know Your Values

Before exploring how to start ethical investing, take time to clarify your own values and priorities. Are you primarily concerned about climate change, human rights, diversity or corporate behaviour? Different investors have different ethical priorities, and there’s no one-size-fits-all approach.

Sarah Williams, a financial adviser at Ethical Investment Solutions in Manchester, recommends creating a personal “values inventory” before making any investment decisions. “List the issues you care most about, then rank them in order of importance,” she suggests. “This becomes your ethical compass when evaluating investment opportunities.”

Understanding your values will help you navigate the sometimes complex world of ESG ratings and avoid investments that might contradict your personal beliefs. It also helps manage the inevitable trade-offs that come with ethical investing – few companies score perfectly across all ESG metrics.

The financial markets offer various options that can align with different values. For environmentally-conscious investors, climate focused investment funds provide exposure to companies developing solutions for climate change or demonstrating leadership in reducing carbon emissions.

Once you’ve identified your values, you can begin researching investments that align with them. This leads to our second principle.

2. Understand ESG Screening Methods

Ethical investment screening criteria are the methods used to evaluate companies based on ESG factors. Understanding these screening approaches is essential for any beginner investor.

Negative screening excludes companies involved in controversial activities like tobacco, weapons, gambling or fossil fuels. This is the oldest and most straightforward form of ethical investing. For example, many UK ethical funds exclude the entire oil and gas sector based on environmental concerns.

Positive screening seeks out companies making positive contributions to society or the environment. This might include renewable energy producers, healthcare companies improving access to medicine or businesses with exceptional employee welfare programmes.

Best-in-class screening selects the companies with the strongest ESG performance within each sector. This approach recognises that even in high-impact industries like mining or manufacturing, some companies demonstrate significantly better practices than others.

ESG integration incorporates ESG data alongside traditional financial metrics when evaluating investments. Rather than applying absolute screens, this approach considers how ESG factors might affect a company’s financial performance.

What is ESG investing without proper screening? Potentially just another form of conventional investing. Effective screening ensures that your investments truly reflect your ethical priorities while helping to manage risk.

The UK Investment Association reported that 38% of UK assets under management applied ESG integration approaches as of December 2020, highlighting the growing importance of these screening methods in mainstream investment practices.

3. Look Beyond Labels

When building ethical investing portfolio examples, it’s important to look beyond marketing labels and conduct thorough research. Terms like “ethical,” “sustainable,” “green” and “responsible” lack standardised definitions and can sometimes be used as marketing tools without substantial backing.

This phenomenon, known as “greenwashing,” involves companies or funds exaggerating their environmental credentials to appeal to ethical investors. Similarly, “social washing” and “governance washing” involve misleading claims about social impact or corporate governance practices.

To avoid falling prey to these tactics, dig deeper into the actual holdings and policies of any fund marketing itself as ethical. Many sustainable investing without greenwashing strategies involve examining a fund’s complete holdings list, not just its top investments. Pay attention to the fund’s voting record on shareholder resolutions related to ESG issues, as this can reveal whether its actions match its marketing claims.

The Financial Conduct Authority (FCA) has increasingly focused on tackling greenwashing in the UK investment market. In October 2022, the FCA proposed new rules requiring sustainability claims to be substantiated, prohibiting exaggerated or misleading sustainability claims and ensuring sustainability-related product features are consistent with the product’s broader characteristics.

Dr Rachel Carson, a sustainable finance researcher at the University of Edinburgh Business School, notes: “The discrepancy between marketing claims and actual investment practices remains a significant challenge in the ethical investment space. Investors need to develop a healthy scepticism and the skills to evaluate these claims critically.”

4. Consider Performance Expectations

A common concern for newcomers to ethical investing is whether prioritising ESG factors means sacrificing financial returns. Research on ethical investing performance and returns shows a more nuanced picture than the old assumption that ethical investing necessarily underperforms conventional approaches.

A 2020 study by Morningstar found that the majority of ESG funds outperformed non-ESG funds over one, three, five and ten years. Similarly, research by the University of Oxford and Arabesque Partners reviewed 200 studies and found that 88% of companies with robust sustainability practices demonstrated better operational performance and cash flows.

However, it’s important to maintain realistic expectations. ESG funds may perform differently from conventional funds during certain market cycles. For instance, during periods when fossil fuel stocks are rallying, funds that exclude these sectors might temporarily underperform.

The key insight is that ESG investing doesn’t necessarily mean accepting lower returns – in fact, considering ESG factors can help identify well-managed companies positioned for long-term success. At the same time, performance will vary based on specific investment strategies, time horizons and market conditions.

“When evaluating performance, it’s crucial to consider appropriate time horizons,” explains James Mitchell, Head of Responsible Investment at Brewin Dolphin. “Many ESG factors affect company performance over the long term rather than quarter to quarter.”

For beginners, this means setting realistic expectations and understanding that the relationship between ESG factors and financial performance is complex and evolving.

5. Start with ESG Funds

For those wondering how to build an ethical portfolio, starting with ESG funds can be less overwhelming than selecting individual stocks. These funds pool money from multiple investors to create diversified portfolios that meet specific ESG criteria.

Several types of ESG funds are available to UK investors:

• Ethical investing mutual funds: These traditional funds are actively managed by professional fund managers who select investments based on both financial and ESG criteria.
• Exchange-Traded Funds (ETFs): These funds trade on stock exchanges and often track ESG indices like the FTSE4Good Index or MSCI ESG Leaders Index.
• Investment trusts: These closed-ended funds can be particularly suitable for investing in less liquid ethical assets like renewable energy infrastructure.

When evaluating best ethical investment funds, consider factors beyond just the ethical criteria. Look at the fund’s expense ratio (annual management fee), historical performance, risk level and the fund manager’s experience. The average annual charge for ethical funds in the UK is around 0.85%, though this varies widely.

Several UK investment platforms now offer specialised ethical investment options. Platforms like Interactive Investor provide ethical investment lists to help beginners identify funds aligned with specific values. Their “ACE 40” list categorises ethical funds into “Avoids,” “Considers” and “Embraces” based on their approach to ESG issues.

“For beginners, broad-based ESG funds provide instant diversification across companies, sectors and geographies while maintaining ethical standards,” notes Emma Wall, Head of Investment Analysis at Hargreaves Lansdown. “This can be less risky than concentrating on specific impact themes or selecting individual stocks.”

6. Diversify Responsibly

Just as with conventional investing, diversification remains essential when building an ethical portfolio. Spreading investments across different asset classes, sectors and geographies helps manage risk while maintaining alignment with your values.

The principles of diversification in socially responsible investment funds mirror those of traditional investing, with a few additional considerations:

Asset class diversification: Include a mix of equities (stocks), fixed income (bonds), property and possibly alternative investments like infrastructure. Each asset class has different risk-return characteristics and ESG considerations.

Sector diversification: Some ethical investors inadvertently end up overexposed to certain sectors (like technology) while avoiding others (like energy). While this may align with values, it can increase portfolio volatility. Consider ethical options across various sectors for better risk management.

Geographic diversification: ESG standards and practices vary globally. Investing across different regions provides exposure to diverse approaches to sustainability while reducing country-specific risks.

Impact theme diversification: If focusing on impact investing, consider spreading investments across multiple themes (climate, healthcare, education, etc.) rather than concentrating on a single area.

Building a diversified ethical portfolio might involve combining funds with different approaches. For example, pairing a broad-based ESG fund with more targeted thematic funds focusing on specific issues like gender equality or clean energy.

“Responsible diversification means being intentional about both financial risk and ethical considerations,” explains Thomas Reed, Investment Director at Rathbone Greenbank. “It’s about finding the right balance between concentration in areas you care deeply about and sufficient diversification to manage investment risk.”

7. Consider Active Ownership

Ethical investing isn’t just about where you put your money – it’s also about how you use your power as an investor to influence corporate behaviour. This concept, known as active ownership or stewardship, is increasingly recognised as a crucial aspect of environmental social governance investing.

As a shareholder, you have certain rights, including voting on resolutions at annual general meetings and engaging with company management. While individual investors may have limited influence, collective action through fund managers or shareholder associations can drive significant change.

Many ESG fund managers actively engage with companies on behalf of their investors, pushing for improvements in areas like climate strategy, diversity policies or executive compensation. When evaluating funds, consider their engagement record and voting history on key ESG issues.

The UK Stewardship Code, established by the Financial Reporting Council, sets high standards for how investment managers and asset owners engage with companies. Funds that are signatories to this code commit to principles of effective stewardship and report annually on their activities.

For individual investors, options for active ownership include:

• Choosing funds with strong engagement policies and track records
• Attending company AGMs and asking questions about ESG issues
• Supporting shareholder resolutions on climate change, diversity and other ESG topics
• Joining investor networks focused on specific issues

“Active ownership represents the evolution of ethical investing from simply avoiding harm to actively driving positive change,” notes Dr. Jonathan Harris of the Responsible Investment Network. “It recognises that investors have both the right and responsibility to shape corporate behaviour.”

8. Stay Informed About Tax Implications

Understanding the tax benefits of ethical investing can enhance your overall returns while supporting your values. In the UK, several tax-efficient vehicles can be used for ethical investing.

ISAs (Individual Savings Accounts) allow UK residents to invest up to £20,000 per tax year (2022-23) without paying income tax on dividends or capital gains tax on profits. Many investment platforms offer ethical options within ISA wrappers, providing tax efficiency alongside values alignment.

SIPPs (Self-Invested Personal Pensions) offer tax relief on contributions based on your income tax rate, tax-free growth and the ability to take 25% as a tax-free lump sum from age 55 (rising to 57 in 2028). SIPPs can include various ethical investments, making them suitable for long-term ethical investing.

The UK government has introduced several tax incentives specifically for environmental investments. For example, the Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS) offer tax reliefs for investments in early-stage companies, including those developing environmental technologies.

Investments in certain renewable energy infrastructure projects may qualify for Business Property Relief, potentially reducing inheritance tax liabilities. Meanwhile, Community Investment Tax Relief provides income tax relief for investments in disadvantaged communities through Community Development Finance Institutions.

“Ethical investing and tax efficiency aren’t mutually exclusive,” explains Catherine Morgan, a Chartered Financial Planner specialising in ethical finance. “With careful planning, investors can structure their ethical portfolios to maximise available tax benefits while staying true to their values.”

It’s worth noting that tax rules change frequently and some tax-efficient investments carry higher risks. Consulting with a financial adviser who understands both ethical investing and tax planning can be particularly valuable in this area.

9. Embrace Technological Innovation

The final principle for beginner ethical investors is to consider how technology is transforming the accessibility and effectiveness of ethical investing. From ethical robo advisor portfolios to advanced ESG data analytics, technology is making it easier than ever to invest according to your values.

Robo-advisors – automated investment platforms that build and manage portfolios based on your risk tolerance and preferences – increasingly offer ethical investment options. Platforms like Wealthify, Nutmeg and EQ Investors in the UK provide pre-built ethical portfolios with different risk levels and ethical focuses, often with lower minimum investments than traditional financial advisers.

Mobile apps dedicated to ethical investing are making research and investment more accessible. Apps like Clim8 focus specifically on climate-positive investments, while others provide ESG ratings and information to help investors make informed decisions on the go.

Advanced data analytics are improving the quality and granularity of ESG information available to investors. Companies like Sustainalytics, MSCI and Refinitiv provide increasingly sophisticated ESG ratings based on thousands of data points, helping investors better understand the ESG performance of potential investments.

Blockchain technology is beginning to enhance transparency in ethical investing by creating immutable records of supply chains, carbon offsets and impact outcomes. This could help address greenwashing by providing verifiable evidence of companies’ sustainability claims.

“Technology is democratising access to ethical investing while simultaneously making it more effective,” notes Fintech analyst Samantha Jenkins. “Tools that were once available only to institutional investors are now accessible to everyday investors, enabling more people to align their investments with their values.”

Beginners can leverage these technological innovations to simplify their entry into ethical investing while benefiting from increasingly sophisticated ESG analysis.

Putting Principles into Practice

Now that we’ve explored the nine principles, let’s consider how to put them into practice when building your ethical investment portfolio.

Start small and gradually increase your allocation to ethical investments as you become more comfortable with the approach. Many investors begin by allocating a portion of their portfolio to an ethical fund while maintaining some conventional investments.

Consider working with a financial adviser who specialises in ethical investing. These professionals can help you navigate the complexities of ESG investing while ensuring your portfolio meets both your ethical and financial objectives. The UK Sustainable Investment and Finance Association (UKSIF) maintains a directory of financial advisers who specialise in ethical investment.

Regular reviews of your ethical portfolio are essential, not just for financial performance but also to ensure continued alignment with your values. Companies and funds change over time, and what qualified as ethical when you first invested might not meet your standards a few years later.

Keep learning about both fundamental investment principles and evolving ESG issues. Resources like Ethical Consumer magazine, Good With Money and the Mindful Money podcast provide ongoing education about ethical investing approaches and opportunities.

Perfect ethical purity is rarely achievable in investing. Most companies have complex supply chains and operations that involve some degree of ethical compromise. Focus on progress rather than perfection, recognising that your investments can encourage positive change even in imperfect companies.

The Path Forward: ESG Investing in the Years Ahead

As we look ahead, several trends are likely to shape the future of ethical investing, creating both opportunities and challenges for investors.

Regulatory developments, particularly in the UK and EU, are driving greater standardisation and transparency in ethical investing. The EU’s Sustainable Finance Disclosure Regulation (SFDR) and the UK’s planned Sustainability Disclosure Requirements (SDR) aim to reduce greenwashing and provide clearer information to investors.

Climate change continues to dominate the ethical investing landscape, with growing interest in both climate mitigation (reducing emissions) and adaptation (preparing for climate impacts). Carbon neutral investment options are expanding beyond niche products to become mainstream investment considerations.

Biodiversity loss is emerging as the “next climate change” for investors, with increasing recognition that economic activity depends on healthy ecosystems. The Taskforce on Nature-related Financial Disclosures (TNFD) is developing frameworks for companies to report on biodiversity impacts, similar to climate reporting.

Social issues are gaining prominence in ESG analysis, accelerated by the COVID-19 pandemic and movements for racial justice. Investors are paying closer attention to how companies treat workers, address diversity and inclusion and contribute to community wellbeing.

Technology ethics, including data privacy, algorithmic bias and digital rights, represents a frontier for ethical investing as technology becomes increasingly central to business and society. Funds focusing specifically on responsible technology are beginning to emerge.

Corporate governance and ethical investing connections are strengthening as investors recognise that good governance underpins both environmental and social performance. Specific governance issues like executive compensation, board diversity and tax transparency are receiving greater investor attention.

What is ESG investing likely to become in the future? Probably less a distinct category and more the standard way of investing, as ESG factors become integrated into mainstream investment analysis. This integration reflects growing recognition that environmental, social and governance issues materially affect company performance.

Moving Forward: Making an Impact While Building Wealth

Ethical investing represents a powerful opportunity to align your financial goals with your personal values. By following the nine principles outlined in this article – understanding ESG concepts, clarifying your values, researching beyond labels, setting realistic performance expectations, starting with funds, diversifying responsibly, embracing active ownership, optimising tax efficiency and leveraging technology – you can build an investment portfolio that works toward both profit and purpose.

For beginners, the most important first step is simply to start. You don’t need to transform your entire portfolio overnight or achieve perfect ethical alignment immediately. Begin with one ethical fund or investment, learn from the experience and gradually expand your approach as your knowledge and confidence grow.

Resources like the Ethical Investment Research Services (EIRIS), Share Action and the UN Principles for Responsible Investment provide valuable information for continuing your ethical investing journey. Many UK investment platforms also offer educational resources specifically focused on ethical investing approaches.

Ethical investing is ultimately personal – there’s no universally “correct” approach. Your ethical investment strategy should reflect your unique values, financial goals and risk tolerance. What matters most is making conscious, informed decisions about how your money affects both your financial future and the world around you.

By integrating these principles into your investment approach, you can join the growing movement of investors who believe that capital can – and should – generate both financial returns and positive impact. In doing so, you’ll not only work toward your own financial goals but also contribute to building a more sustainable and equitable future.

The top ESG stocks to buy will continue to evolve as companies adapt to changing environmental and social challenges. Impact investing for beginners will likely become more accessible as platforms develop simpler ways to match investors with opportunities aligned with their specific values. Whatever approach you choose, the growing infrastructure supporting ethical investing makes this an exciting time to align your investments with your values.