Nonprofit investing can be especially complex. Of all the challenges facing nonprofit foundations and endowments, issues surrounding finances and investing are especially hard. In the last decade, many nonprofits have experienced funding cutbacks. Even those whose funding has remained stable are finding that money has to go further to meet increased client loads and demands on programs and services.

Professionals who understand the unique needs of nonprofit organizations can be particularly effective in helping an organization fulfill its purpose without having to add staff. At Bartlett, we offer a wide range of nonprofit investing strategies, along with client-focused service, to a variety of nonprofits.

Here are three key areas to consider when thinking about nonprofit investing.

1. Construct a strong portfolio

Do you have a suitable strategic asset allocation that matches with your needs and goals? Appropriately investing short-term working capital can help preserve financial flexibility while maximizing resources. If your group has an infusion of cash that won’t be spent immediately, such as a contribution for a capital spending project, consider alternatives for putting at least some of it to work rather than letting it sit idle.

Does your portfolio reflect broad diversification across equity and fixed-income markets? Nonprofit investing with an eye to the long term is particularly important with stocks. Historically, equities have typically outperformed bonds, cash, and inflation, though past performance is no guarantee of future results and those returns also have involved higher volatility. Your strategy should take into account that the market will not go in one direction forever — either up or down. However, it’s instructive to look at various holding periods for equities over the years. Historically, the shorter your holding period, the greater the chance of experiencing a loss.

Have you considered nonprofit investing options that aren’t strongly tied to traditional equity and fixed-income asset classes? The term “alternative investment” is highly flexible; it can mean almost anything whose investment performance is not correlated with that of stocks and bonds. It may include physical assets, such as precious metals, real estate, or commodities. An alternative asset’s lack of correlation with other types of investments gives it potential to complement more traditional asset classes and provide an additional layer of diversification for money that is not part of your core portfolio, though diversification cannot guarantee a profit or ensure against a loss.

Is your portfolio structured to minimize cost for maximum return? Advocates of unmanaged, passive investing — sometimes referred to as indexing — have long argued that the best way to capture overall market returns is to use low-cost market-tracking index investments. Devoting a portion rather than the majority of your portfolio to actively managed investments can allow the organization to minimize investment costs that may reduce returns.

2. Set a sound spending policy

Nonprofits have not been spared the increases in for-profit health care costs and worker’s compensation insurance that have hit corporations and small businesses. Yet fundraising for such mundane areas as day-to-day operations, staff salaries, and building and equipment maintenance has traditionally been one of the biggest challenges for nonprofits.

The twin effects of inflation and increased client loads have underscored the importance of having an adequate operating reserve. Also, corporate sponsorships can be vulnerable to the mergers and acquisitions that occur frequently in the corporate world. It makes sense to ensure a diversity of donors rather than relying on a few traditional sources.

But with global equities historically producing 4% to 6% returns, and global fixed income around 2% to 3%, it’s challenging for nonprofits to stay ahead of their spending. The average spending rate for private foundations is nearly 6% annually, according to a 2016 Council on Foundations study. We recommend keeping your spending low, closer to a 4% target.

3. Watch out for biases

Remember that the people who make up your nonprofit investing committee are also human beings—which makes them susceptible to some very human biases. Be on the lookout for these decision-making behaviors that could lead to unfavorable investments for your nonprofit:

• Overconfidence: As many investors have learned the hard way, becoming overly optimistic about investing during the good times can be as detrimental as worrying too much during the bad times. The right approach during all kinds of markets is to be realistic. Have a plan, stick with it, and strike a comfortable balance between risk and return.
• Prospect theory: People value gains and losses differently, and, as such, will base decisions on perceived gains rather than perceived losses. Thus, if a person were given two equal choices, one expressed in terms of possible gains and the other in possible losses, people would choose the former—even when they achieve the same economic end result. According to prospect theory, losses have more emotional impact than an equivalent amount of gains.
• Home bias: Some investors have the tendency to invest in a large amount of domestic equities, despite the purported benefits of diversifying into foreign equities. Investors often exhibit home bias due to a preference for investing in what they are already familiar with rather than moving into the unknown.
• Herd behavior: When individuals mimic the actions of a larger group, they could make irrational decisions. Keeping your cool can be hard to do when the market goes on one of its periodic roller-coaster rides. It’s useful to have strategies in place that prepare your organization both financially and psychologically to handle market volatility. Having predetermined guidelines that recognize the potential for turbulent times can help prevent emotion from dictating decisions.

In the face of an ever-challenging environment for nonprofits, it is important to set up your organization’s investments in a way that will best support the charitable mission over the long run.  Being mindful of investment structure, spending policies and biases will better position your investment funds for the long run.