So you think investment policies are only for not-for-profits with millions to invest? Not true. If your organization holds funds in reserve — for example, to cover emergencies or meet long-term goals — it’s prudent to have investment policies. Such policies will help ensure that you manage reserve funds responsibly according to their purpose and take steps to minimize investment risk.
Creating investment policies begins by defining the purpose of different funds or investment pools. Some not-for-profits maintain only one investment pool, lumping current operating funds with reserve funds and combining restricted with designated and short-term with long-term funds.
If this is the case with your organization, you need to differentiate these pools according to their purposes, time horizons and any restrictions or designations that may apply to them. To ensure you’re properly categorizing the funds, consult legal and accounting documents, such as your organization’s bylaws, donor agreements, board minutes, and cash flow models.
Establishing your organization’s investment policies will first require that you identify the objectives, unique circumstances, and the oversight responsibilities that you will require within your not-for-profit. After you’ve identified separate investment pools, create written investment policies and guidelines for each one. A pool’s purpose and time horizon will be critical.
Short-term pools are used to pay operations-related bills, and these funds may be needed at any time on short notice. For such a pool, your investment objectives should include safety, liquidity and, possibly, yield. Typically, the best and safest short-term investments are money market funds, Treasury bills, certificates of deposit and short-term, high-quality bonds.
Long-term pools include endowments, contingency reserves and funds designated or restricted for making major improvements. Here, the investment objectives generally are growth and capital preservation, which may be achieved by investing in high-quality equities, longer-term bonds and some short-term investments. If you’re seeking a constant income stream, you may want to stagger bond maturities so that an interest payment comes due every month.
For all of your pools, consider whether you want to prohibit certain investments that conflict with your not-for-profit’s mission or a donor’s wishes. A cancer research charity, for example, might ban tobacco company stocks from its portfolio.
In addition to identifying each pool’s specific return objectives and permissible investments, address each asset class’s minimum and maximum allocations. For instance, your investment committee may decide that equities should represent no less than 30% and no more than 60% of the total investment pool.
Such asset allocation guidelines are important when determining a portfolio’s potential risks and returns. Studies have shown that asset allocation decisions account for more than 90% of a portfolio’s total return – far exceeding the importance of individual security selection.
Occasionally, more financially conservative or less investment-savvy board members may recoil at the idea of buying stocks for a not-for-profit’s portfolio. Remind them that portfolios that diversify investments by including a small percentage invested in common stocks historically have produced higher returns with less risk of loss than portfolios consisting entirely of fixed-income investments.
You should include in your not-for-profit’s portfolio different assets whose price movements generally don’t follow each other. For example, intermediate maturity bonds and mortgage-backed securities do little to diversify a portfolio because their price movements generally are related to interest rate movements. However, intermediate maturity bonds typically have a low correlation with the price movements of common stock, so combining the two in a portfolio can reduce overall risk.
If your board or investment committee contains knowledgeable investors — for example, CPAs, bankers or financial planners — you might allow them to make asset-allocation decisions. Otherwise, work with a professional money manager, at least initially. Once you’ve chosen investments, your not-for-profit may be able to monitor performance, adjust weightings and make trading decisions on its own. Larger not-for-profits almost always have a money manager to consult with the group making the final decisions. Note that your investment policies should state who is responsible for and authorized to make such decisions.
Don’t wait for your organization to receive a major gift before writing investment policies. The sooner you start thinking about responsible money management, the better prepared you’ll be when one day you have stewardship of a large endowment.
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Councilor, Buchanan & Mitchell (CBM) is a professional services firm delivering tax, accounting and business advisory expertise throughout the Mid-Atlantic region from offices in Bethesda, MD and Washington, DC.