Investment policies are not only for nonprofits with millions to invest. If your organization holds funds in reserve — for example, to cover emergencies or meet long-term goals — it’s prudent to have investment policies. In reality, any time funds are invested it is important to have a policy to follow. Such policies will help ensure that funds are managed responsibly, according to their original purpose and assure the Organization is taking take steps to minimize investment risk.
Combining Funds
Creating investment policies begins by defining the purpose of different funds. Some nonprofits maintain only one investment account, lumping current and long-term funds and operating funds with donor restricted funds.
If this is the case with your organization, you should differentiate the funds 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. There should also be consideration of segregating the funds to reduce the administrative burden of tracking and bifurcating earnings.
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 nonprofit. After you’ve identified separate investment categories, create written investment policies and guidelines for each one. A categories’ purpose and time horizon will be critical.
Short-term investments are used to pay operations-related bills, and these funds may be needed at any time on short notice. For such, 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 investments include endowments, contingency reserves and funds designated or restricted for making major improvements or long-term operational needs. 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 investments, 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.
Allocating Assets
In addition to identifying each investment categories’ 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.
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.
Your nonprofit portfolio should include 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.
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. For any questions related to investment policies or general nonprofit accounting consultation, contact Dalena McGrew at dmcgrew@vlcpa.com or 800.887.0437.
