Question: If I donate to a favorite charity of mine, how will they invest the money? Are there guidelines they must follow?
Answer: Non-profit charities have board members who have a fiduciary duty to govern the investment and management of their institutional assets in a prudent manner. Their duty to govern does not mean that board members should make day to day investment decisions. Their responsibility is to make sure that the investment program is right for the institution. They can provide good governance for their investment program by appointing a competent investment committee consisting of members who are thoughtful, informed, wise, capable of good judgment, and experienced as investors.
If the board finds this task too daunting, they can ask their local Community Foundation about a Stewardship Fund, which can serve as a proxy for them. The investment committee’s first and foremost task is to formulate, in writing, an Investment Policy Statement. This statement, once approved by the board, serves as the governing document for managing the institutional assets and provides written documentation of the charity’s investment philosophy and investment guidelines. It must conform to legal requirements of California’s Corporations Code and Uniform Prudent Management of Institutional Funds Act (UPMIFA).
Another reason for developing an investment policy and for putting it in writing is to enable the board to protect the management of institutional assets from ad hoc revisions of a sound long-term policy. Without an investment policy, in time of market turmoil, investment committee members and board members are often inclined to make impromptu investment decisions that are inconsistent with prudent investment management principles. The institution’s investment policy will provide a well thought out framework from which sound investment decisions can be made.
The California Corporations Code states that the board shall “Avoid speculation, looking instead to the permanent disposition of the funds, considering the probable income, as well as the probable safety of the corporation's capital.” It further states that “Nothing in this section shall be construed to preclude the application of the Uniform Prudent Management of Institutional Funds Act...if that act would otherwise be applicable, but nothing in the Uniform Prudent Management of Institutional Funds Act alters the status of governing boards, or the duties and liabilities of directors.”
UPMIFA provides charitable institutions with a handbook for good governance in the form of a standard of care for both managing and investing an endowment. It requires the board to act in good faith with the care of an ordinary prudent person, to incur only appropriate and reasonable costs, to diversify its investments, and to analyze each investment in the context of the total portfolio. It allows a charity to invest in any kind of property that is not inconsistent with the standard of care.
UPMIFA recognizes that the definition of prudent investing has evolved from the old and outdated “prudent man rule” that narrowly focused on safe, income producing securities to the new “prudent investor rule” that encourages the use of modern portfolio theory. It shifts the focus on income from interest and dividends to total return and encourages using a risk versus return analysis with recognition that adding a riskier investment to a properly diversified portfolio can improve the overall portfolio return and reduce its overall risk.
Kenneth B. Petersen CFP®, EA, MBA, AIFA® is an investment advisor and Principal of Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey. He welcomes questions that you may have concerning investing, taxes, retirement, or estate planning. Send your questions to: Ken Petersen, 2340 Garden Road Suite 202, Monterey, CA93940 or email them to firstname.lastname@example.org.