When you read up on philanthropy, you hear one word an awful lot: impact.
Obviously that makes sense. If you just want to make someone’s life better, buy me a Jet Ski. If you want to have as big a positive impact on the world as possible, you are starting down an interesting, under-traveled, and complicated road.
Clearly, one of these things is not like the other. And that should serve to clarify the stakes. But even charities with the same objectives can differ widely in terms of their effectiveness. Last month, Eric Friedman, CFA, made the point that some charities can make life-saving interventions for a fraction of the cost of other organizations.
So, by using the right approach, you can save more than 600 lives for the cost of one. Conservatively.
That sort of gap in performance denotes opportunity for investors, both in optimizing personal giving and in helping clients achieve the same efficiency. Friedman and I connected over email to take the discussion a bit further, but certainly the hope is that it does not end here. We would both appreciate it if you would share your own questions in the comments section below.
Will Ortel: One of the most influential concepts in investing is the idea of “efficient” markets, which basically states that it is difficult to beat the market because the best investment opportunities are spotted quickly and buyers bid up the price to fair value. Does this same principle apply in charitable giving?
Eric Friedman, CFA: Somewhat, but not as much as in investments. A lot of donor money goes to the nonprofits that are best at fundraising, not necessarily those with the best programs.
Fundraising success is more correlated with being able to tell compelling stories rather than being charities with evidence-based programs demonstrated to have a strong impact. Further, donors often constrain their giving to areas that they relate to, so causes that are not personally appealing to upper-middle-class and wealthy donors tend to be neglected.
As a result, there are broad swaths of extremely effective charities that have huge funding gaps.
There are some very savvy donors trying to close these gaps, but they are small relative to the total amounts donated. For example, grants from the Bill and Melinda Gates Foundation, which is one of the most sophisticated donors and the largest foundation by far, are only about 1% of the size of what Americans donate annually.
Investors frequently complain about not having access to enough information in making investment decisions. The same complaint is probably relevant for charities, but can you compare the information that decision makers use in both contexts?
A key difference between information available to investors and donors is that the regulatory environment for information-sharing is much stricter for investments. For example, mutual funds have to disclose many things about their strategies, and their marketing material is tightly controlled to minimize their ability to over-promise or mislead. Investment firms typically can’t highlight a single winning position without disclosing their whole portfolio performance.
The same cannot be said about charities. While that might make donors cautious, there are also reasons to be more optimistic about the quality of information available.
In the for-profit sector, participants protect their trade secrets and competitive advantages. In contrast, participants in the not-for-profit sector have aligned interests — making the world better — so there is greater potential for sharing information.
In both investing and donating, there are experts who are professionally skilled at identifying the best places to allocate capital. One of the biggest differences is that in the investment world, those experts often guard that information as trade secrets, while experts in the charitable sector more frequently share it publicly.
We are all familiar with portfolios where risk and return are balanced. Can the idea of optimizing risk and return be applied to charitable giving?
One of the most important questions when considering a giving opportunity is the level of evidence that it will be effective. This can be thought of as tied to the level of risk. Some interventions have a lot of evidence, sometimes even being tested with similar scientific practices to what pharmaceutical companies are required to use to get new medicines approved. Other giving opportunities are not conducive to such hard evidence, such as with policy advocacy or research.
As with investing, the lowest risk approach isn’t necessarily the best, but taking risk is only desirable if it has the possibility for an outsized return — or impact.
Charitable giving doesn’t have a quantitative “efficient frontier” in the same sense as exists in investing, but risk and return are still important ideas.
If I give without using this framework or a similar one, what are the risks?
In the investing world, an adviser who is unconcerned about risk and return would undoubtedly be breaching fiduciary duties. With charitable giving, if you’re not focused on the evidence behind your approach and the potential outcomes, then you’re flying blind with respect to impact.
The impact of a charity is fundamentally tricky to understand. Can you talk about that?
Sometimes donors only take a surface look at the evidence for impact, which can lead them in the wrong direction.
For example, many people who want to support education donate to college scholarships without thinking through how much the scholarships actually increase education versus facilitate people graduating with less debt.
Or worse, scholarships may enable universities to get away without controlling costs. It isn’t clear without a fairly deep understanding of the dynamics, but it is very possible that the impact of this type of donation is less than a donor might initially expect.
In contrast, giving to some causes might be greater than what one might assume on initial consideration. For example, research indicates that treating parasitic intestinal worms in developing world countries actually increases educational and economic outcomes in addition to health, possibly by the flow-through effects of improved nutrition.
This is an important reason why using intuition alone is often not a good strategy to maximize charitable impact.
How does this compare to some of the key ways donors have historically evaluated charities?
A lot of donors emphasize financial efficiency, such as evaluating charities based on the percentage they spend on overhead. The problem is that there can be very lean organizations that are not especially effective. In fact, “overhead” costs can often be critical for the success of a nonprofit, such as program evaluations and competitive salaries for quality staff.
To create an analogy to the investing world, don’t you want the companies you invest in to spend money on marketing, R&D, and technology? Similarly, a certain level of overhead is critical for charities.
Of course, donors can rest assured that a wasteful organization is unlikely to have a high impact by any legitimate measure. I think the nonprofit community as a whole now recognizes that it is better to evaluate the program impact of a charity. This is a more difficult task than computing a few ratios from a charity’s IRS filings, but well worth the added effort.
Many advisers shy away from talking about charitable giving with their clients because they view it as too complex or not their specialty. Is there something that simplifies the research process and gives donors access to a broadly diversified, rigorously constructed basket of charities?
Yes. There are several charity evaluators that do very robust research and share their results publicly. The really good ones only give their top ratings to a handful of the most deserving charities.
The group I work with, The Life You Can Save, aggregates research from several reliable sources to provide a broader list of recommendations than any one source individually. Importantly, we try hard to present the information in a way that is easy to digest for both financial advisers and donors.
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This post was first published by CFA Institute.