Creating a Successful Investment Strategy

Developing an investment strategy is one of the most important responsibilities of your board of directors. Here is a guide to creating a sound investment policy for your organization.

Step 1: Map Out Your Objectives

First, clearly set the objectives of your investment portfolio. This requires long-range planning that includes:

• Projecting your organization’s growth and need for additional facilities,

• Creating a capital spending plan, and

• Considering the volatility of future funding for operations.

Step 2: Work Within Your Restrictions
Most of the time your board of directors will have requirements that must be considered. Requirements can be imposed by the governing board, donors and local law.

Board restrictions . Usually referred to as designations, these requirements can normally be reversed by a subsequent board resolution.

Donor restrictions. You may receive donations with explicit or implied restrictions. Restrictions are explicit when the donor stipulates what portion of a gift may be used and how it may be used. These stipulations usually cannot be changed without consent of the donor. Implied restrictions result when your organization requests money for a specific purpose. Even when a donor does not stipulate how funds are to be used, restrictions were created when the donor responded to your request for funds for a specific purpose. Restrictions can cover the gift and income gained from the gift.

Legal restrictions. In reviewing legal requirements, remember that trust law and corporate law generally differ. The structure of your organization (as a corporation or as a trust) may have significant implications for the definition of income and how income is to be used. Current generally accepted accounting principles require most for-profit and nonprofit organizations to value their investments at market value. This may affect your definition of income because unrealized appreciation will be included in income.

Step 3: Create an Investment Plan
After you have developed objectives and you understand the legal requirements, you can begin to develop an investment policy.
Start by determining the risk you will need to assume to achieve your financial goals. Generally, greater risk accompanies higher return objectives. For example, a higher tolerance for risk would indicate investing a greater portion of your portfolio in stocks that have performed better than fixed rate instruments over the long term. A low tolerance for risk will force you to invest in instruments — such as certificates of deposit — that most likely have a fixed rate of return and little principal volatility.

An alternative to starting with a judgment about your risk tolerance is to start with your performance objectives. Let’s assume that you wish to spend 5% annually and retain another 4% to 5% as a hedge against inflation. Armed with this objective, you can more readily determine the most conservative portfolio that can meet your combined performance objectives (9% to 10%).

Regardless of your decision about investment performance vs. risk tolerance, here are a few things that you can do to improve investment performance:

• Take a total return approach to investing. This means that the portfolio is invested for maximum return consistent with your tolerance for risk. This is in contrast to investing for a specific type of result such as maximizing current interest and dividend revenue or maximizing gains. An objective of maximizing some component of investment return is generally less effective than a total return approach.

• Pool different funds. If you have different types of funds that must be used in specific ways, you can physically merge investments while accounting for them separately.

Generally speaking, a larger portfolio will improve diversification, reduce fees and even permit investments with better rates of return, such as jumbo certificates of deposit.

• Determine the point at which you should consider an individually managed portfolio vs. a portfolio of mutual funds.

Usually, it will be more cost effective to have an individually managed portfolio for amounts over $500,000.

• Determine whether to manage your portfolio with a professional manager. If you use an outside investment manager, he or she must be clear on your objectives, risk tolerance and investment performance objectives. In selecting a manager, verify his or her familiarity with your type of organization and the size of your portfolio.

Nonprofits Need Profitable Investments
Achieving your organization’s goals can often hinge on the soundness of your investment management strategy. Take time today to outline the right plan for your nonprofit. If you have any questions, call us. We can help you work within your restrictions, set objectives and create your investment plan.