How Should Nonprofits Invest Their Funds?

Nonprofit organizations manage funds for long-term sustainability and program delivery. Investing funds prudently generates additional resources beyond direct donations, securing future operational capacity. Unlike for-profit entities, nonprofit investment strategies prioritize supporting charitable activities rather than maximizing short-term shareholder returns. Effective investment management provides a stable financial foundation, enabling consistent program delivery and long-term organizational health.

Establishing Investment Guidelines

A fundamental step for nonprofits is creating a comprehensive Investment Policy Statement (IPS). This document serves as a blueprint for all investment activities, ensuring continuity and consistency in decision-making even as board members change over time. The IPS helps the board fulfill its fiduciary responsibilities, particularly the “duty of care” as outlined in principles like the Uniform Prudent Management of Institutional Funds Act (UPMIFA) adopted in many states.

The IPS should articulate the organization’s investment objectives, which typically include preserving capital, achieving long-term growth, or generating income for operations. Understanding potential returns and risks across asset classes is necessary to set achievable goals. For endowments, a common objective is to maintain the real purchasing power of assets in perpetuity while supporting a defined spending rate. This requires the long-term return objective to account for inflation, fees, and annual distributions.

Defining the nonprofit’s risk tolerance is another component of the IPS, representing the acceptable ratio of risk to reward for investment returns. This assessment helps prevent poor investment outcomes and protects donor confidence. Factors influencing risk tolerance include the time horizon for fund use and the organization’s overall financial stability. An overly cautious approach can erode purchasing power, while excessive risk-taking can jeopardize liquidity.

A spending policy within the IPS details how the nonprofit determines the annual draw from its investment portfolio to support current operations without depleting the principal. This often involves a percentage of a rolling average market value, ensuring a sustainable distribution stream. For example, an endowment might specify distributing a limited percentage, such as 5%, of the account’s total market value annually.

Asset allocation guidelines outline investment diversification across various asset classes to manage risk and pursue objectives. While not detailing specific securities, this section sets targets and allowable ranges for categories like equities and fixed income. The IPS should also include rebalancing procedures to maintain these target allocations over time. This framework ensures the portfolio remains aligned with the organization’s long-term goals.

Many nonprofits also integrate ethical and mission-related investing considerations into their IPS. This involves aligning investment choices with the organization’s values and mission, often incorporating Environmental, Social, and Governance (ESG) factors. ESG investing considers a company’s practices in areas like environmental impact, human rights, diversity, and corporate governance. Such an approach allows the entire portfolio, not just program spending, to contribute to the organization’s broader mission.

Selecting Investment Vehicles

Once investment guidelines are established within an Investment Policy Statement, nonprofits consider specific investment vehicles for their portfolios. These tools are chosen to align with the defined objectives, risk tolerance, and asset allocation targets. Understanding the characteristics of each vehicle helps in constructing a diversified portfolio.

Equities, commonly known as stocks, represent ownership in companies and are typically included for their potential for long-term growth. While offering higher growth potential, stocks also come with increased risk and volatility. Nonprofits often hold stocks as part of a balanced strategy to generate revenue for their mission.

Fixed income investments, such as bonds, generally provide more stability and a steady income stream compared to stocks. These include government bonds, corporate bonds, and other debt instruments. They serve a role in diversifying the portfolio and reducing overall volatility. Cash equivalents, like money market funds, certificates of deposit (CDs), and Treasury Bills, are highly liquid and low-risk options used for short-term needs and maintaining financial flexibility. CDs, while safe, offer less flexibility and liquidity due to fixed interest rates and maturity periods.

Mutual funds and Exchange-Traded Funds (ETFs) are popular pooled investment vehicles that allow nonprofits to achieve diversification across various stocks and bonds more easily. These funds hold a basket of securities, providing instant diversification and professional management.

Alternative investments are considered by some nonprofits, particularly those with larger endowments, to enhance diversification and potentially reduce volatility. These include assets outside traditional stocks, bonds, and cash, such as private equity, hedge funds, real estate, and infrastructure. While they can offer unique market opportunities and potentially higher returns, alternatives often involve higher fees, lower liquidity, and require specialized expertise. Certain alternative investments, like real estate and infrastructure, may also serve as hedges against inflation.

Oversight and Monitoring

Ongoing oversight and monitoring are important after a nonprofit’s investment portfolio has been established. This continuous process ensures the portfolio remains aligned with the organization’s strategic objectives and adapts to changing market conditions. The board of directors maintains ultimate fiduciary responsibility for the organization’s assets.

Regular performance reviews assess how the investment portfolio is performing against established benchmarks and the IPS. Benchmarks can be relative, comparing performance to an index like the S&P 500, or absolute, measuring against a target annual rate of return that accounts for distribution, inflation, and fees. Performance should be evaluated periodically, with benchmarks reviewed at least annually to reflect current conditions.

Portfolio rebalancing is the process of adjusting the asset allocation back to the target percentages defined in the IPS. This helps maintain the desired risk level and ensures the portfolio does not drift too far from its strategic allocation due to market fluctuations. Rebalancing procedures should be outlined in the IPS, with ranges set at both the portfolio and individual asset-class levels.

The nonprofit’s board of directors, often through a dedicated investment committee, plays a central role in overseeing the investment strategy and performance. This committee’s responsibilities include drafting investment policies, hiring and overseeing external investment managers, and setting performance goals. Committee members have a fiduciary duty to monitor assets, review reports, and ensure transparent communication with the board and other stakeholders. The board approves the investment committee’s charter and the IPS, which should be reviewed and updated annually.

Engaging professional investment advisors is common for nonprofits, as these advisors offer expertise in portfolio management and cash management strategies. Advisors help develop IPS documents, assess risk tolerances, and provide ongoing reporting and analysis. They act as fiduciaries, meaning they have a legal responsibility to act in the organization’s best interest. Working with an advisor can free up internal staff time and provide specialized knowledge to navigate complex financial markets and regulatory changes.

Clear and regular reporting of investment activities and performance to relevant stakeholders is also a continuous requirement. The IPS should include guidelines for measuring investment performance and specify how often the investment committee will evaluate the portfolio. This ensures transparency and accountability to the board, staff, and donors regarding the stewardship of funds.