Episode 95: Nonprofits' Investments - How to Help Plan for the Future

Welcome to another edition of "Around with Randall," your weekly podcast making your nonprofit more effective for your community. And here is your host, the CEO and Founder of Hallett Philanthropy, Randall Hallett.

I thank you in advance for taking some time to join me, Randall right here on around with Randall. Today's discussion is around investments and investment decisions with nonprofits. What we know is that coming out of the pandemic, in particular, those first let's say multiple months into the first year, a lot of organizations, particularly those that are a little bit larger with variable revenue streams like education, because students weren't maybe going to college, or healthcare who had to shut down or do business differently, depended on, in many cases, some type of endowment or investment fund that their organization had raised over the course of time. And as we come out of the pandemic, and now we're into this area of inflation and we know that we've had a drop in the stock market, although it's up in the last maybe month, it's down overall. If we just use the Dow Jones as one indicator maybe not always the best, but it's easiest to know from you know the mid 36,000s down to 33-34,000 investment funds have taken a hit and all of a sudden there's conversation and questions around what is the best process the best answer to how to invest or manage invested funds.

Two specific instances brought me to this particular subject in today's podcast. The first was an interesting illumination where I became aware of a nonprofit who was acting with their invested funds more like a private equity investment firm that they, instead of investing in the stock market, and not all their funds just a portion or small portion, but I found it interesting is that they were investing some of their dollars into individual companies and actually taking ownership stake in those companies. And that eventually their goal was to be paid back at a higher rate or have an opportunity to recoup those monies from maybe sale of that portion. I'll comment on that in a second.

The second was an article that came out on August 9th in the Chronicle of Philanthropy dealing with foundation investment choices, written by Mark Gunther, talking about the choices of how to use or to invest those funds. And the fact and the argument in the article was that they're, that nonprofits are doing it incorrectly and are losing money. And in fact losing opportunity to invest in the community or use the funds by the nonprofit mission. The article's headline is what got me. Foundation investment choices potentially lose $20 billion a year for grantees. Really what they're saying is based on the fact, and we'll get into this in a minute, that if they invested it differently they'd make more money.

So let's go back to the private equity conversation first. I found this incredibly startling. If I was a donor to that particular organization and had an endowed fund and found out that they were, this is my term nobody else's, chasing returns to get a more dollars in those endowed funds or those investment funds by investing in private equity, I'd be darn mad. I would be furious. In fact I'd want my money back to invest in another kind of organization. This is actually a true situation. Names aren't that important and aren't going to be shared, but that's what this particular larger nonprofit's doing. And I thought, wait a minute, if I have invested my philanthropic dollars into the organization and they're being used to create something in perpetuity, why in the world would I ever want a high risk investment into an individual small private business to be a part of what the investment strategy is. Because if that money's gone, who's gonna make it up? We know that owning a small company, I'm one of them, can be risky. Not all small businesses are successful and I'm sure there's a lot of due diligence done and all of those things, but I was just disturbed by it.

On the heels of that became the article kind of an interesting two-week period where two things kind of isolated came together. The article in the Chronicle Philanthropy discusses the fact that money managers that invest professionally are performing or underperforming decisions. If the organization had invested the same amount of money in a low-cost index fund they would have done better because they wouldn't have paid the money manager, they could have just gone to a Fidelity or a Schwab and put it into a low-cost index fund and that index fund would have moved with the markets. And over the course of time you would have done better and the argument is that, why pay money managers if you can do it yourself? Added to that, I did a little research and came up with a study done in 2018 and then kind of some updates in 2021 done by an academic study done by Dyad and Irmak who are two researchers who came back with thousands thousands of nonprofits reviewing their investments over a period of about 15 years from, I'm sorry, nine years from 2009 to 2018 finding out the same. That money market managers, your investment advisors, weren't beating the markets. If you just invested them in you know 60:40 ratio index funds.

And this led me to today's discussion. How does your organization make the decision about how to invest? Well there's three, or excuse me, four real options that you have as a nonprofit for your investment process. The first is a wealth advisor or an investment advisor, and they are individuals who do this professionally by the numbers as discussed. They usually don't beat some low-cost investment, low cost index funds in those investments. Others process to choose them if the organization is big enough. They might split the money and have different people invest different percentages, so it's not all in one pot. There's usually fees involved with that, and that's a part of this process. There's obviously a middle man now between the organization's money and the money itself or the organization, it's money you can't get to it quickly. It does provide, if done correctly, a great deal of transparency because there should be a great deal of documentation how things are invested. A lot of reporting that comes from any investment that you do with a professional advisor, wealth advisors, investment advisors, number one.

Number two is DIY. Do it yourself. There are people who do this normally. This reduces obviously those fees, but it also puts an additional burden on the organization to come up with a committee, or a small group, or actually not recommended an individual who may be on the board or on the finance or investment committee who does it for you. And it may not offer you the reporting that an organization might need because it's only reporting might be what you ask at that time uh it's not great oversight because you're putting one person or small group with direct control in charge of those invested funds. So protocols and stop-gap measures may not be in place, and it requires an extensive if done correctly. Expertise. You're looking for a certain group of people on your board or on that finance and governance or finance and investment committee, and without them you could be in real trouble.

The third option is what's money market and deposit accounts. This is literally like putting it in a savings account and the annual return over time has been about one tenth of one percent. Now in the last year, in 2022, if your money was sitting in the right money market account with inflation, it might be a little higher but the problem is that as inflation has grown dramatically, you're never going to keep up. And so while it's incredibly safe, the risk is almost nil. The reporting is easy because it's bank statement, basically, if you think about it that way. There's no minimum requirement. There's a little capital appreciation, and as a result, there's little growth, which means you're losing the battle against inflation almost every year. So the money today is worth more in your organization than it will be tomorrow and certainly in a year or two.

The last one is what they call automated investing, or robo investing, which the best way to put this is like what we see in what I would call age appropriate index funds or college investments, 529 plans. And they they invest based upon factors that include how quickly you need the money, how important the money is, what happens at certain points in the organization. So if you're dealing with a college investment fund like for my children as they get older and closer to college, the risk of those investments decreases depending on the inputs of the organization. Those decisions, they may not maybe need the money. It's invested for let's say, a capital project, in five years so the first year it's a little more risky. But by the fifth year you're going to need it. So they reduce that risk. It's automated so that's a little cheaper because you really aren't dealing with a wealth advisor but it's more than DIY. The problem is that it only returns about 90 percent of what the management companies, the wealth advisors, investment advisors are providing so there's a little more security. It's not as risky but you're losing ground, particularly if inflation continues at eight, nine, ten percent over the next year.

So there's four. You got an advisor. You do it yourself internally. It sits in a savings account, or you automate a process. Basically those are the four. So what does all of this mean for us? Well, let's talk about the tactical. In some of the things that are most important, first foremost, before you do anything else your organization needs a robust reviewed, detailed investment policy. Who makes the decision? So part of that is which one of these four things do we do? And depending on any one of those four what are the processes we go through? If it's an advisor or series advisors, do we divide the funds? How often do we review, or the investment committee of the board review their returns? Who from the organizations are part of these conversations? What are the thresholds for decisions to be made, i.e pulling the money out and giving it to another investment firm? Does it have to be done through the board or through the investment committee? What are the risks the organization's willing to take, meaning you can set boundaries to say we aren't very aggressive. So make them investments very conservative, or we want to be aggressive. We have certain parameters around what we invest in. We're seeing more and more aspects of socio, socio-social ecology investment strategies. And now they may not draw as much particular return but the organization is making a social statement on, we don't invest in oil as an example.

A great investment policy can save you a lot of problems. If you're not reviewing that investment policy as an organization on annual basis, you're making a fatal mistake. At the end of the recommend, at the end of the, what we can learn the, tactical, I'll make up maybe my own thought on recommendation which is the best policy in terms of how you invest, but no matter what you do if you don't have that investment policy you're asking for trouble. Get it in writing. Get it reviewed. Have the board approve it. Review it on an ongoing basis. That is the most essential thing you can do as an organization. And if you haven't read your investment policy, no matter what level of employee or you're just on a board, you're making a mistake. Ask someone for the investment policy. This is going to guide you in a lot of these particular conversations.

Number two is my belief in just general investing is that it's a long-term process and that not completely conservative, but reasonably conservative investments will benefit you in the long term. We used to operate in the individual retirement space that the 5% rule that you know you would have x amount of dollars and to figure out how much money you'd have once you retired you'd do 5% per year as an investment amount, and that would keep the corpus, the amount that you've invested, the same. And what's happened the last several years is somebody finally figured out say that's too high, it needs to be 4%. And now you're beginning to hear 3% and the reason why is that investment strategies can change with economic times and if you bank on too much on an annual basis, it can be concerning. So having something in your investment policy about a three-year running average and we want to average 4% or 3% that's going to get you a bigger endowment and keep that endowment over time. The other thing is that investment policies or thoughts need to also be on the revenue side. Just because, and I'll use again me as an example, we established a fund in my parents name for kids to go to college at the high school school district we went to and we're, I'm not depending on them just investing, that we're putting more and more money into the corpus so how you work with your fundraising team to get them to give you money or get money or to find donors to put more money into those accounts can be just as fruitful as a really aggressive but risky investment policy, so don't just stop raising money in those funds.

The third tactical thing deals with what my, at least my thought process is on the best investment process strategy. I am a big believer in wealth advisors, but I'm a big believer in wealth advisors by giving them the right instructions that it's my belief that our organizations and our boards over the long term don't have the discipline or the expertise to do this correctly. In a DIY situation and putting them in a savings account is not a viable option because you can end up running on money and automated investing, I think, is an interesting conversation but doesn't take into account the annual ups and downs of the economy. And also the organization's and its budget concerns so I go back to wealth advisors. But I also want to give them very strict instructions. My concern with the DIY is literally one person can destroy an endowment or a small group, probably not purposely, but it's too much power in one particular position. An investment committee in partnership with wealth advisors with the right instructions about what risk and what's appropriate and what's not through an investment policy can guide you to the best balancing act of risk and return. And the article fights against that in the Chronicle of Philanthropy, and I respect the math that they put out, but I also would argue that they don't ever even mention the comment about having the right talent or the discipline that an organization would have to have to never take it out of an index fund, never chase returns. And one group of people, because boards change, might have one philosophy. You go four or five years down the road you've got new board members, they may have a different philosophy. And if you don't have something in that policy, and I think in some ways outside advisors you are at the whims of the group that's in power at that moment. And I don't think that's a good thing. I don't think that's healthy. So in the end, taking these pieces of information from the podcast and just best practice, that investment policy is critical. And having hard detailed individual conversations, internally, and then with your board about what's best for organization really is the winning solution. And that you have options. The question is which options you execute.

At the end, endowments are going to become more and more important. I think dollars are going to become tighter and I think philanthropy is going to change the next 10 years. And those organizations with endowments are going to be the ones that are long-term viable in terms of the missions they believe in, and and and then apply to their community. Thus it's important to have them either in small parts or in totality, but investing them correctly is quintessential to long-term success.

Don't forget to check out the blogs on the website, hallettphilanthropy.com. Two or three a week, 90 second reads, post some on linkedIn. Give you a chance to kind of think of some things, look at some things, give you context and if you want to communicate with me, email me at podcast@hallettphilanthropy.com. Glad to chat with you and if you have a suggestion for the show I'd appreciate that as well. If you're listening to this on Downcast or iTunes or now Apple or Spotify or whatever, leave me a review, share it with a friend. Maybe it could be helpful for them in their nonprofit career. Don't forget the work that you're doing, the work the organization is doing is critical to your community, and you're making a difference. Your organization's making a difference. That mission you believe in is making a difference. Remember my favorite saying, some people make things happen, some people watch things happen, then there are those who wondered what happened. What we want to be, what we try to to strive for are to be people who make things happen, to partner with people in our community who want to make things happen for the people and things that are wondering what happened, and that makes our community a better place. Non-profit philanthropy fills the holes for the forgotten, for the underrepresented, for the hurt, and that makes what we do every day a noble cause. I'll look forward to seeing you right back here on the "Around with Randall" and don't forget make it a great day.