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Developing Investment Policies: How All Nonprofits Can Benefit

Posted by Concannon Miller on Tue, Jan 19, 2021

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Developing Investment Policies: How All Nonprofits Can BenefitSo you think investment policies are only for nonprofits 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.

Pooling Funds

Creating investment policies begins by defining the purpose of different funds or investment pools. Some nonprofits 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.

Making Rules

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 nonprofit's mission or a donor's wishes. A cancer research charity, for example, might ban tobacco company stocks from its portfolio.

READ MORE: Nonprofit Cash Management: Steps to Take Beyond the Annual Budget

Allocating Assets

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.

Promoting Diversity

Occasionally, more financially conservative or less investment-savvy board members may recoil at the idea of buying stocks for a nonprofit'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 nonprofit may be able to monitor performance, adjust weightings and make trading decisions on its own. Larger nonprofits 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.

READ MORE: 7 Best Financial Practices for Nonprofit Organizations

Do It Now

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.

© 2021

Topics: Nonprofit Organizations

Concannon Miller’s unique, holistic and intimate approach to financial health sets us apart from smaller CPA firms with more limited resources as well as mega firms where mid-sized clients struggle for attention. Contact us here to talk about improving your business.

This communication is designed to provide accurate and authoritative information in regard to the subject matter covered at the time it was published. However, the general information herein is not intended to be nor should it be treated as tax, legal, or accounting advice. Additional issues could exist that would affect the tax treatment of a specific transaction and, therefore, taxpayers should seek advice from an independent tax advisor based on their particular circumstances before acting on any information presented. This information is not intended to be nor can it be used by any taxpayer for the purposes of avoiding tax penalties.

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