Donor advised funds (DAFs) are flexible tools which can be used for a number of charitable giving purposes. One increasingly popular use is to use a DAF in lieu of a private foundation, given that DAFs are cheaper to operate, more tax efficient, more flexible, and eligible for higher limits on tax deductibility of contributions. For those with charitable intentions of leaving a legacy that will continue to have an impact on the world many years into the future, an “endowment-style” DAF may be a great alternative to a traditional perpetual foundation. However, while much attention has been given to how individuals should allocate a portfolio throughout their own lifespan, considerably less attention has been given to the question of how to best allocate a portfolio if one’s time horizon is “forever”.
In this guest post, Dr. Derek Tharp – a Kitces.com Researcher, and a recent Ph.D. graduate from the financial planning program at Kansas State University – analyzes considerations when coordinating investment and spending policies of an endowment-style DAF, finding that for donors who have the willingness to be flexible in their distribution policy, investment allocations that are much more aggressive than those commonly adopted by endowments may generate far more income for charitable beneficiaries and build a larger endowment value to sustain giving well into the future.
For many, the first place to look for guidance on endowment allocations may naturally seem to be the many colleges and universities managing endowments – ranging from the multibillion-dollar endowments at some of the most prestigious universities in the world, to the fairly modest endowments of smaller, regional universities. However, despite the attention that these endowments often get, this may not be the best approach for donors, as the reality is that colleges and universities have a much higher need for distribution stability (in order to fund ongoing operating costs that universities have become highly dependent on) than the typical donor funding institutions which are not dependent on a single donor’s gifts. Which means, despite the fact that many smaller universities tend to build endowment allocations roughly akin to a 60/40 or 70/30 portfolio, an ideal allocation for a typical donor may look much different.
As it turns out, allocation considerations can have a tremendous impact on the amount of funds that ultimately go to charities, although the uniqueness of a 100+ year time horizon (relative to the 30-40 year time horizons financial advisors are more familiar with) makes the size of the impact hard to intuitively grasp. For instance, Monte Carlo analysis based on historical market returns suggests that shifting a fairly modest $100k endowment-style DAF from a balanced portfolio allocation (50/50) to an aggressive allocation (100/0) would result in an extra $13.6 million in inflation-adjusted median endowment account value after 100 years, while generating an addition $5.6 million in distributions to charitable institutions along the way! Further, adopting a simple dynamic spending strategy (e.g., forego a distribution in years with less than a 2.5% real return), results in an additional $6.1 million boost in real residual value and $1.2 million more in charitable distributions, despite the fact that distributions are being skipped in some years!
Ultimately, the key point is to acknowledge that willingness to accept some spending instability can result in substantially more assets going to the charitable institutions that donors care about. Of course, donors must be willing to stay the course, avoid projecting their personal risk tolerance onto the endowment, and be comfortable adopting an allocation that is much more aggressive than the “norm” among prominent endowments… but donors should be cognizant of the tremendous potential if they are willing to be flexible. The long-term compounding effects are huge!
source https://www.kitces.com/blog/donor-advised-fund-daf-endowment-style-asset-allocation/?utm_source=rss&utm_medium=rss&utm_campaign=donor-advised-fund-daf-endowment-style-asset-allocation
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