When should nonprofits spend more?

Here’s a quote about a program by Habitat for Humanity to try to get better results for people:

By betting big on property in a down market, and with the help of a donor network, the group is creating Habitat neighborhoods.
Habitat for Humanity Tries Big-Scale Approach to Housing in Oregon

That’s one point of endowments: counter-cyclical spending, like dollar-cost averaging over generations. There’s a rule of thumb in foundations (as with retirement spending) to spend 5% of the endowment per year. Most people believe that this is some magic rule, or that it’s been calculated to provide the optimal balance between short-term needs and long-term outcomes. Ain’t so.

Private foundations have, generally speaking, an incentive to spend at least 5% of the fair market value of their assets as a way of avoiding certain excise taxes (meaning additional taxes) on their income. In general, the IRS’s idea is that foundations should not become black holes into which money flows and never comes out for whatever charitable purpose was claimed in the first place.

However, many organizations treat this 5% not as a floor but as a ceiling. Admittedly, it’s hard to figure out what the right choice is when you have an endowment the size of Harvard’s, for example. Harvard talks about using the endowment, and answers their own softball question about spending. They note that they tend to spend more after low investment returns and less after high returns, but then they say that they generally budget before the numbers are in, so it’s not clear how much of this is intentional counter-cyclical spending versus just smoothing the budget. Ultimately, though, they say that they have many restricted funds and they are “obligated” to use it for the future.

Yes, but…. If you assume that current spend has no future value, then that argument makes sense. But, as the Habitat example shows, using funds to achieve your charitable purpose is the charitable purpose.

Back to Habitat. I first became acquainted with nonprofits from a legal perspective when I volunteered for a San Francisco Bar Association program that sought and trained corporate lawyers to provide corporate and governance advice to nonprofits. Around that time, I’d read an article about homelessness in San Francisco that described some of the groups fighting the problem. I realized then, mostly in jest but with real concern, that there may well have been more people fighting homelessness in SF than there were homeless people. And I wondered about the relationship between the budget and resources spent on the problem versus the actual cost to solve the problem directly.

Over time, that question has become less silly-sounding than it was in 2000:

  1. L.A. spends $100 million a year on homelessness, city report finds – LA Times
  2. Utah fights homelessness with homes

I love this stuff. Spend $1m out of moral outrage, or $8k out of cheapness. I’m not a liberal. I’m a libertarian. And if spending less money solves the problem, why would anyone complain about that? Spending less money on and through government comes with lots of positive externalities, such as smaller government, fewer dollars to be skimmed by graft, and reduced “intervention” in life by government. Oh, and it actually gives people places to live. We deserve our problems if we won’t choose cheaper solutions over more expensive fights.

We’ve written about nonprofit metrics before, and we’ll write about a related issue when we discuss nonprofit M&A.