Cash sitting in a charity bank account costs money, so if you have lots of it, invest some;
But the obvious ways to invest (i.e. stocks) work poorly when combined with countercyclical spending.
Charities are normally risk-averse about investments because they have plenty of money to invest when stocks are high, but need to draw down reserves when stocks are low.
That’s a good point and I don’t think I was particularly clear in my post. I will have a think about whether I can rephrase in a way that keeps it concise.
I’d like to separate my response into two issues: (1) liquidity (cash vs. Treasuries) and (2) risk tolerance (Treasuries vs. stocks). On liquidity, I think it’s a good idea to keep a few months of expenditure in cash to ensure you can access it in an instant. Depending on your size, you may get some interest paid by the bank, but it’s very unlikely to keep pace with inflation. However, anything you don’t need at short notice can be invested in risk-free assets (e.g. short-dated US Treasuries), which have a better chance at keeping pace with inflation (with the usual caveat that the benefits have to outweigh the added admin).
Risk tolerance, i.e. whether to invest in stocks (maybe even with leverage) rather than Treasuries, is another topic and lots of smart people have written previous stuff on this, e.g. here. This is where the practical difficulties I mention come in. You need to be willing for income (including potential gains and losses on investments) and expenditure to be going in opposite directions, potentially over a number of years. Certainly, if a charity has 6 months’ expenditure in the bank, I wouldn’t recommend putting 3 months worth in stocks. But if a charity has 10 years’ expenditure in the bank, I think it needs to realise how much that is costing it. If it puts 9 years’ expenditure in stocks, then with even a bad market crash, it will still have 5 years’ expenditure.
10 years worth of cash sounds pretty unusual, at least for an EA charity.
But part of my point is that when stocks are low, the charity won’t have enough of a cushion to do any investing, so it won’t achieve the kind of returns that you’d expect from buying stocks at a no-worse-than-random time. E.g. I’d expect that a charity that tries to buy stocks would have bought around 2000 when the S&P was around 1400, sold some of that in 2003 when the S&P was around 1100 to make up for a shortfall in donations, bought again in 2007 at 1450, then sold again in 2009 at 1100. With patterns like that, it’s easy to get negative returns.
Individual investors often underperform markets for the same reason. They can avoid that by investing only what they’re saving for retirement. However, charities generally shouldn’t have anything equivalent to saving for retirement.
I think what you are referring to is an Anti-Nightingale. If you always sell after a market crash, you will most likely (as in mode, not mean) have poor returns, but that doesn’t change the expected value from investing. The odds of a roulette wheel never change, but you can change your strategy to give you a >50% chance of coming away with a profit. My strategy will give you a >50% chance of coming away with an underperformance of the market, but will not change the underlying odds.
Another trap some people (including professional investors) fall into is “buying the dip”. It feels natural to expect that when the market is low, the future expectations must be higher and it must be a good time to invest. In a perfect market (not a given!) this is not the case. In fact due to government responses (lowering the interest rate), returns should actually be lower. In very practical terms, this time last year you might have expected a 6% return from investing in the S&P 500 for one year. Right now, that 6% might be 5.5% because interest rates are lower.
But the obvious ways to invest (i.e. stocks) work poorly when combined with countercyclical spending. Charities are normally risk-averse about investments because they have plenty of money to invest when stocks are high, but need to draw down reserves when stocks are low.
That’s a good point and I don’t think I was particularly clear in my post. I will have a think about whether I can rephrase in a way that keeps it concise.
I’d like to separate my response into two issues: (1) liquidity (cash vs. Treasuries) and (2) risk tolerance (Treasuries vs. stocks). On liquidity, I think it’s a good idea to keep a few months of expenditure in cash to ensure you can access it in an instant. Depending on your size, you may get some interest paid by the bank, but it’s very unlikely to keep pace with inflation. However, anything you don’t need at short notice can be invested in risk-free assets (e.g. short-dated US Treasuries), which have a better chance at keeping pace with inflation (with the usual caveat that the benefits have to outweigh the added admin).
Risk tolerance, i.e. whether to invest in stocks (maybe even with leverage) rather than Treasuries, is another topic and lots of smart people have written previous stuff on this, e.g. here. This is where the practical difficulties I mention come in. You need to be willing for income (including potential gains and losses on investments) and expenditure to be going in opposite directions, potentially over a number of years. Certainly, if a charity has 6 months’ expenditure in the bank, I wouldn’t recommend putting 3 months worth in stocks. But if a charity has 10 years’ expenditure in the bank, I think it needs to realise how much that is costing it. If it puts 9 years’ expenditure in stocks, then with even a bad market crash, it will still have 5 years’ expenditure.
10 years worth of cash sounds pretty unusual, at least for an EA charity.
But part of my point is that when stocks are low, the charity won’t have enough of a cushion to do any investing, so it won’t achieve the kind of returns that you’d expect from buying stocks at a no-worse-than-random time. E.g. I’d expect that a charity that tries to buy stocks would have bought around 2000 when the S&P was around 1400, sold some of that in 2003 when the S&P was around 1100 to make up for a shortfall in donations, bought again in 2007 at 1450, then sold again in 2009 at 1100. With patterns like that, it’s easy to get negative returns.
Individual investors often underperform markets for the same reason. They can avoid that by investing only what they’re saving for retirement. However, charities generally shouldn’t have anything equivalent to saving for retirement.
I think what you are referring to is an Anti-Nightingale. If you always sell after a market crash, you will most likely (as in mode, not mean) have poor returns, but that doesn’t change the expected value from investing. The odds of a roulette wheel never change, but you can change your strategy to give you a >50% chance of coming away with a profit. My strategy will give you a >50% chance of coming away with an underperformance of the market, but will not change the underlying odds.
Another trap some people (including professional investors) fall into is “buying the dip”. It feels natural to expect that when the market is low, the future expectations must be higher and it must be a good time to invest. In a perfect market (not a given!) this is not the case. In fact due to government responses (lowering the interest rate), returns should actually be lower. In very practical terms, this time last year you might have expected a 6% return from investing in the S&P 500 for one year. Right now, that 6% might be 5.5% because interest rates are lower.