Last Updated on December 2, 2024
Overview – Ethics and Investing
If you were given the chance to become an overnight billionaire, would you take it? Assuming this offer doesn’t immediately cloud your judgment, one of the questions you’ll likely ask is “on what conditions?”
What if you find out that, upon taking this offer, the portfolios of millions of other investors are decimated in the process. Who these millions of investors are can include anyone, from a wealthy institutional investor all the way to a young married couple simply trying to build up enough funds to get their children through school.
Would you still take this offer, knowing that you benefit at the expense of millions?
Now, most people don’t become investors with the anticipation of needing to deal with ethics. After all, why would they? Many investors work on their own and don’t directly impact the lives of others.
However, like most endeavours, it’s only a matter of time before the issue of ethics pops up. Whether investors like it or not, investing isn’t exempt from ethics.
Why Worry About Ethics, Anyways?
According to the Merriam-Webster dictionary, ethics is defined as follows: “the discipline dealing with what is good and bad with moral duty and obligation.”
I don’t claim to be an expert on ethics, but I like to think of it as making the distinction between what is morally right and wrong.
Before we start our discussion of ethics in investing, let’s take a look at ethics in other professions. I’m an engineer by training, so let’s look at ethics in engineering.
The engineering regulatory body in my province of Alberta, APEGA, has a clear code of ethics that all practicing engineers in the province must follow.
This code isn’t simply for show. Assuming you work as an engineer and you violate the code, you run the risk of your ethical breach being reported to APEGA.
Depending on the severity of the breach, consequences can range from some sort of sanction all the way to losing your APEGA membership, meaning you are no longer allowed to practice engineering in Alberta.
Not only that, but if you’re lucky enough to keep your APEGA membership after the violation, this ethical breach is now part of your APEGA records, which may make it difficult to renew your membership in the future.
Imagine losing your ability to work as an engineer simply because you chose to do something that was morally wrong.
If you think engineers don’t need to concern themselves with ethics, let’s look at the following scenario.
Imagine one of your loved ones works in a high-rise building, and one day the building’s supports fail and ultimately collapses, killing your loved one along with many other people.
How would you react if investigators found out that one of the principal engineers behind the design of the building wasn’t trained in structural engineering, leading to this disaster? To add insult to injury, you find out that this individual took on the job of designing this building simply because the project promised very generous pay.
Would you still view engineers as trustworthy professionals? If engineers continued to put personal gain ahead of the interests of the public, do you think the public would continue to trust engineers as well?
In essence, this code exists to remind engineers that they ultimately serve the people and the public interest – if the public no longer trusts engineers and the work they do, then the profession is as good as dead.
In engineering, ethics goes beyond simply determining what’s right and wrong. Ethics grant engineers the social license they need to continue to do their work – it’s so much more than simply determining what’s right or wrong.
Now, investors may not necessarily serve the public, but ethics still apply to investing, regardless of what type of investor you are.
Do Investors Need to Worry About Being Ethical?
One of the traits that make investing unique is that not all investors invest in a professional capacity (I’ve previously talked about the different types of investors).
There are some individuals, such as mutual fund managers or university endowment managers, who are paid to make investment decisions on behalf of someone/something else, thus making investing their job.
On the other hand, there are some individuals who invest solely for themselves. Anyone who isn’t paid to make investment decisions on behalf of someone/something else, therefore, falls into this category.
If you work as a school teacher but you have money in index funds, then you are, by definition, a non-professional investor. It’s not your profession to make investment decisions for someone else, your profession is to teach.
If that’s the case, why concern yourself with being ethical? After all, there is no legal requirement demanding that investors be ethical. As long as an investor makes money, it doesn’t matter how they make it, right?
Not necessarily.
From my experience and through my own observations, I’ve learned that although investors aren’t required to have a strong sense of ethics, it’s in their best interest to do so.
Let’s look at professional investors first, such as fund managers.
Fund managers are responsible for investing on behalf of other people. The money they are investing with isn’t their own, but rather is the money of all their clients.
Imagine a fund manager chooses to pursue an investment opportunity that benefits them personally but represents a major investment risk to the clients. If you were one of the clients and found out, how would you feel? Would you continue to view fund managers as professionals if all it takes to sway them is to gain something at the expense of their clients?
If you’re the fund manager that committed this ethical breach, good luck trying to convince prospective clients that you won’t jeopardize their money. Not only that, but depending on the severity of what you did some regulatory bodies may now keep a close eye on you. All this is the result of a fund manager deciding to put their clients’ money on the line while they stand to benefit.
Or perhaps you’re a retail investor and are presented with an opportunity to perform a prohibited inside trade (i.e., performing a trade with critical information that is unavailable to the rest of the investing public) with minimal chances of getting caught. Would you still proceed, knowing that the legal consequences for insider trading are very severe?
Assuming you do get caught, you are now a criminal, making your professional and personal life that much harder. I’m sure I don’t need to tell you all the difficulties that come with having a criminal record to your name, especially one as severe as prohibited insider trading. This could’ve been avoided entirely had you simply decided to put ethics ahead of your greed.
So, to answer the question posed in this section’s heading: yes, investors have a valid reason to worry about ethics, sometimes for the benefit of others (fund managers, institutional investors), but also for their own good (retail investors).
Investors aren’t required to be ethical per se, but investing is set up in such a way that it discourages unethical behaviour, and severely punishes those who push their luck.
If your gut tells you that a course of action is unethical because it is morally wrong, your best bet is probably to listen to your gut and avoid putting yourself in a very precarious situation.
It Pays to Be Good, Literally
Have you ever noticed that, whenever you abide by the rules and don’t do anything questionable, you don’t draw any attention to yourself? However, when you decide to be rebellious and push your luck all of a sudden more eyes start to look your way? The same can be said when it comes to abiding by a strong ethical code.
Having strong ethics does more than make investors feel good about themselves. They ultimately prevent investors from landing themselves in some very hot water and helps make an investor’s journey that much smoother. Start doing something that pushes the limits of what’s morally right or wrong and you’ll soon start to draw attention to yourself.
Back to our engineering example from earlier, the code of ethics states that its purpose is to uphold the dignity and image of the engineering profession. While this is true, you don’t need to be a genius to realize that the code of ethics also exists to help engineers avoid any legal, reputational, or other adverse consequences in their careers.
By ingraining the ethical mindset of doing work you’re trained to do, make safety a top priority, and follow all pertinent laws/regulations, it becomes increasingly unlikely for an engineer to accidentally get in trouble. The engineers who do perform ethical breaches, at least in the history of APEGA, are mostly ones who willingly broke the code.
Similarly, when investors adopt a strong sense of ethics the hope is that it becomes more difficult for them to do something illegal or questionable.
When a fund manager decides to adopt a strong sense of ethics, they greatly minimize the risk of putting their clients’ money at stake, allowing them to keep their job, improve their reputation, and potentially attract more clients in the process.
A retail investor that refuses to compromise on ethics will most likely build a very robust investment portfolio without worrying about doing something illegal or attracting unwanted attention.
Ultimately, an investor loses nothing but stands to gain a lot by choosing to maintain strong ethical standards.
In terms of financial gain, an investor who maintains a strong sense of ethics can be rewarded in a number of ways: capital appreciation, increased dividends, increased interest payouts (from fixed income securities), and access to new investment opportunities as their experience and capital grows.
There is a valid financial incentive to have strong ethics as an investor, and there are endless consequences for those who choose to forego ethics.
Wrapping Up
For some investors, ethics may be one of the last things they think about, but that attitude should change. Whether they like it or not, investors cannot escape ethics.
By definition, ethics is the act of choosing between what is morally right or wrong. Making ethical decisions may sound like a “feel good” action, but that isn’t totally the case – having a strong sense of ethics makes it very difficult to accidentally do something illegal or questionable.
Investors who choose to make an unethical decision, such as performing a prohibited insider trade or jeopardizing client money, may soon find themselves in some very hot water.
Having a strong sense of ethics may sound superfluous, but investors stand to lose nothing but can potentially gain a lot by having a strong ethical code to abide by.
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