One of the responses to my post on Friday, in which I argued that staffed foundations should share their knowledge to offset the decline in their investment assets, was from people suggesting that foundations should also increase their payout rate. As a general prescription, this is probably a bad idea.
Foundations are required to pay out 5% of their investment assets each year. Why 5% and not some other number? One of the reasons is that there is a rule of thumb in finance that says that a pool of assets invested in a diversified manner has a very high likelihood of sustaining a 5% payout rate forever without depleting the assets. The 5% minimum is essentially the highest level that can be required of foundations without eliminating their option to exist in perpetuity.
I don’t think that all foundations should plan to last forever. But I do think their are valuable benefits to institutionalizing knowledge and creating long lasting organizations. That being said, there are also good arguments to be made for foundations to elect higher payout rates. While doing so may force them to spend down and disband the organization, they may be able to achieve more impact through this strategy.
Too often, proponents of higher payout rates pretend that their is no trade off involved. They imply that foundations can simply pay out higher levels of grants with no impact on future giving. In the comment below, Aaron Dorfman, the executive director of the National Committee for Responsive Philanthropy makes the case for higher payouts. Personally, I think Aaron’s argument ignores the hard reality that foundations that follow his advice are making a simultaneous decision to increase the likelihood that they spend down. But Aaron and NCRP are well positioned to lead the charge on this issue and I’m happy to highlight his views.
For me, your post reinforces the necessity for everyone in our philanthropic community to create an expectation that private foundations do more than is legally required of them.
There was a moment when the recession’s effects first began to be felt when foundations were debating what to do. A few put a halt to grantmaking entirely, realizing that legally they didn’t actually have to make any grants this year to meet their payout requirement. But then nonprofits became more vocal about the threat to their operations in a time of increasing demand and decreasing revenue. A few courageous grantmakers started making public there commitment to maintain grants payout for 2009 at 2008 or 2007 levels. And they did this even though it means their payout rate for 2009 may be 7% or 9% of assets or higher. And this responsible approach became the most socially acceptable response in foundation circles.
We need to start now working to ensure that it becomes unpalatable for foundations to consider cutting back their grants payout in 2010, even if it would be legally permissible. Nonprofits will still be struggling financially well into next year, and they’ll need grantmakers to step up to the plate.
The moral obligations of private foundations go far beyond the legal requirements. Leaders of many private foundations realize this and will act responsibly. We need to highlight their stories and challenge other grantmakers to follow their lead.
Philanthropy requires making tradeoffs. There are good arguments for why foundations should engage in countercyclical grantmaking (giving more during bad times and less during good times). There are also good arguments for planning on spending down. But simply raising payout rates doesn’t tap into a pool of free money. We don’t want to create an environment where it is “unpalatable” for foundations to preserve their very existence. We want an environment where philanthropic actors make tough decisions based on a thorough understanding of the tradeoffs involved.