How to invest the assets in your donor advised fund depends on your goals for the assets.
Donor advised funds are charitable organizations in their own right. For this reason, you to get a charitable deduction in the year you contribute. However, the advisor on the fund retains the authority to grant future gifts from the donor advised fund to other chosen charities. In this way, the donor advised fund serves as a midway point between you and the charities you actually want to support.
The main use of a donor advised fund is to separate the year of your completed gift to charity from the year when your chosen charity receives the funds. You get the tax deduction when you transfer assets to the donor advised fund, but the charity you support receives the money only after you designate a grant to them. This subtle difference can allow significant tax planning, including the use of a giving strategy called gift clumping.
Between the date of your gift to the donor advised fund and the day you grant funds to your chosen charity, the assets in your donor advised fund can be invested.
What asset allocation is appropriate varies depending on the goal(s) of your donor advised fund as well as your own risk tolerance, perception, and capacity with these assets.
The questions to ask to help discern which asset allocation to select are:
- Do you have a specific time frame over which you need the assets in your donor advised fund to last?
- How do you pick the amount that you grant each year? Are the amounts regular and inflexible such as a pledged gift or are they flexible and guided as you feel led?
The answers to these questions make a grid of asset allocation choices:
| Inflexible Giving (You give the same amount each time.) | Flexible Giving (You could give more or less.) | |
|---|---|---|
| Flexible Time Frame (The assets could last more or less time.) | similar to retirement asset allocation design, but matching withdrawals by default | 100% Appreciation (stocks) recommended, although risk tolerance can guide |
| Inflexible Time Frame (The assets must last a specific time.) | identical to retirement asset allocation design | similar to retirement asset allocation design, but leaning aggressive by default |
| Indefinite (The assets must last forever.) | endowment style design (depends on withdrawal requirements and rules) | |
Two Examples from My Life
My husband and I have had two donor advised funds which serve as a good example of these two portfolio designs.
Inflexible Giving over an Inflexible Period
We had one donor advised fund which helped us turn an annual gift into pledged monthly gifts. The charity receiving the funds operates on a month-to-month budget and cannot easily budget from one-time windfalls. To accommodate their preference, we used the donor advised fund to create the monthly gift. We gave twelve times the monthly target to the donor advised fund one time each year and had an automatic monthly withdrawal which grants our pledge to the charity. Once a year, we revisited our giving and donated another batch to the fund if we wanted to support the charity another year.
If the donor advised fund were to lose value, we would have been disappointed that we needed to gift more in order to meet our pledge. And if the assets were to grow beyond our monthly giving needs, we would have had no use for the gains. As a result, we had this donor advised fund invested 100% in cash.
While this missed out on the upside of the market, this matched our intention to turn one-time giving into monthly checks. We had a short time frame (1 year) and an inflexible monthly withdrawal, so we did not even bother getting into a stock allocation.
Flexible Giving over a Flexible Time Period
Our other donor advised fund has no obligations.
We give to the fund whatever we want, and we grant from the fund whatever we want.
If the fund were to lose value, we would not mind. Our charitable grants are not on a specific timeline nor are they required to be a specific size. We grant these charitable gifts at any time and for any reason. If the markets were to lose significant value, we could wait for the account to recover before we withdraw.
Although, even if we were to withdraw during a downturn and impoverish the future account, we would not mind. A Donor Advised Fund account worth less than our starting contribution would not change our future contributions to the Donor Advised Fund nor would it undermine our charitable goals for the assets.
For those with flexible giving like ours, the asset allocation has more room for variation. It could be designed using safe withdrawal rates to guide the asset allocation and help you determine the most giving you can withdraw in a given year. Or it could be set as 100% Appreciation (stock) and left to run its course.
Regardless, selecting a more conservative asset allocation would reduce your safe withdrawal rate and selecting a more aggressive asset allocation would increase your account volatility on both the up and downsides.
Because we have a high risk tolerance and no limiting goals, we invest this Donor Advised Fund as aggressively as possible and hope for the best. We are comfortable delaying a gift when markets are down or impoverishing the future account if we want to give anyway.
Retirement Style Asset Allocation Design
If you have both flexible and inflexible goals, like I had, there is no reason these two donor advised funds need to be separate. In fact, keeping them separate would be falling prey to the Two-Pocket Theory of Money.
Once we added the flexible goals to our donor advised fund, we also had the flexibility to invest more of our inflexible goals. We calculated what withdrawal rate our monthly distribution counted as and updated our Stability allocation to match, as it is described in “Q&A: How Do I Calculate My Withdrawal Rate for My Stability Allocation?” This let our inflexible short-term gift benefit from the markets, gaining the upside. During the downside, our inflexible gift could use funds from our flexible giving, a feature with which we have no problems.
How to Determine Your Goals
The key question to determining your own goals in this and other areas is asking the questions: What does success look like? And what does failure look like?
For my flexible donor advised fund, success is receiving a tax deduction in the size and amount that I have gifted in the year of my gift. Failure would be not being able to satisfy my giving whims when I am ready to issue a grant to the charity. Having to donate more to the Donor Advised Fund or having the assets fall below its starting value are notably not failures for me.
For my inflexible donor advised fund, success is having the charity receive my pledged gift like clockwork each month. Failure would be me having to donate more to the Donor Advised Fund or the charity not receiving the full amount of my pledge.
What is success and what is failure for your donor advised fund will be a personal decision based on why you are interested in a donor advised fund in the first place.
Areas to think about and potentially categorize as a success, failure, or neutral topic are:
- What if the account value falls below the value of contributions? What if it rises above?
- What if the account is emptied in the next year or some other time period?
- What if the account still has assets in it when you die? What if it does not?
- What if you have to contribute more assets to the account to meet your grant target?
- What if there were assets leftover in the account after your grant target?
Clients with large taxable accounts often benefit from donating large amounts to their Donor Advised Fund. They can gift five, ten, or even twenty years of their charitable intentions to their Donor Advised Fund and then use the donor advised fund assets to fulfill their annual charitable intentions over that time period. This large gift helps to remove the annual taxation of interest and dividends from their tax return, lowering their AGI. It also can sometimes be paired with a large Roth conversion to maximize tax savings. We often recommend that a client consider giving a gift clump to satisfy their charitable intentions up to the year they would benefit from qualified charitable distributions. While this kind of giving could have a 100% Appreciation (stock) asset allocation, the answers to the above questions may justify maintaining a Stability (bond) allocation.
If you are opening a donor advised fund for the first time, take a moment to think about your goals. Then, you can set up an asset allocation which is priceless.
Photo by Sasun Bughdaryan on Unsplash. Image has been cropped.
