Private equity investor (E2G)
Co-Treasurer @ EA UK
Trustee @ EA for Christians
Trustee @ ICM UK
Director @ EA Good Governance Project
MBA @ INSEAD
Grayden
Karma: 1,307
Thanks for raising this very important and interesting issue. I think it is well worthy discussion and I’m glad you wrote such a thoughtful piece. I agree with your logic, but disagree with one of your assumptions. You say that “When I leave money in my bank account, it compounds slightly (1-2%, conservatively) faster than world economic growth”. World GDP growth is typically around 3% p.a. in real terms, while the real interest rate is sometime as high as 1-2%, but sometimes as negative. Either way, it is very rate that the real interest rate is higher than world GDP growth.
Keynesian Altruism
These are excellent questions to ask. I’m more sceptical about the three main points than you.
In terms of “pure time preference”, the data shows that the real risk-free rate typically ranges from −1% to +2% and is below that range (i.e. less than −1%), so in the long-run it is minimal and in the short-term it is not there at all.
In terms of the “risk premium”, you can deduce (through a hypothetical portfolio of long S&P 500 forward, short US Treasury) that the risk premium is an argument for selling risk to those who are more risk-averse, but not an argument for waiting. In my post on it, I show how the risk premium is a price for selling risk, not a return on patience.
Finally, “more time to learn and get better” is only relevant if you are thinking about it from a personal rather than system lens. New technologies get cheaper over time only because humanity learns from doing. DVD players were very expensive when the first came out. They became cheaper because the world got better at making DVD Players. As volumes increased, so did scale economies. As manufacturers got experienced in the process, efficiency went up. As supply chains reconfigured to produce the relevant components, those components became cheaper. However, most of this would not have happened if DVD players had not been launched. The same has happened with distribution of mosquito nets and deworming. As EA charities have grown, they have got more experienced, learnt from mistakes and developed supply chains. The price has come down. If I had delayed my donations, I would have been able to buy more nets, but only because somebody else was paying more for them early on while the infrastructure was being built.
What is the frame of reference / underlying units for the percentages you are referring to? It makes a big difference if they are monetary vs. utility, USD vs. EUR, real vs. nominal, etc. When you look at the real life data historically and implied for the future, it is clear that time preference (i.e. real risk-free returns) is pretty neutral, i.e. sometimes you end up with less in real terms and sometimes you end up with more.
A couple of points:
1) “We hence conservatively assume that a skilled investor can achieve 7% expected real returns” – I’m an investor (hopefully a skilled one), but I would certainly not think of 7% as conservative. Yes, historically real equity returns have been c.5%. That is indeed the correct prior to use when forecasting, but you then need to overlay other things about the future. Importantly, while the historically real risk-free was up around 2% for much of the period you quote (source: http://www.econ.yale.edu/~shiller/data/chapt26.xlsx), it is now less than −1% (source: https://www.federalreserve.gov/releases/h15), which should lower your estimate straight away from 5% to 2%. You can boost expected returns through leverage (though as you correctly say, this does have a cost). I would disagree about venture capital investment being higher returns. This may be the case on a post-tax basis, but is not on a pre-tax basis (which is what is most relevant for non-profits). I would not assume you are able to capture any premium from ‘information’. There is a whole industry competing for this and it is hard to do.
2) Your Guesstimate model assumes exogenous learning of +9.3% p.a. This input dwarfs all other variables, so it would be helpful if you could expand on how you reached it. It’s hard to critique something that is not explain (at least as far as I can see), but I think you may have fallen into the trap of looking at historical efficiency improvements brought about by scaling up of technology. As technology improves, the price comes down. But that price only comes down if you develop and manufacture the technology. Moore’s Law didn’t start until humanity built the first computers.
Really interesting article!
I don’t think the reduction in CPLSE is a good estimate of the change in opportunities for the following reasons: (1) CPLSE is very EA specific and EA is a very different movement now compared to 2012; (2) I’m sure AMF and Deworm the World have improved, but I don’t think they would have improved if their founders had sat on the sidelines waiting for research on malaria nets / deworming without actually getting out there and trying things.
My own instinct is that opportunities become more expensive over time. As world GDP increases, average prosperity increases and it becomes incrementally harder to help the ‘poorest’ person.
Yes, I think it would. My only slight hesitation is that it may not be immediately obvious what cycle it refers to. But thank you for the suggestion.
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.
I haven’t. I think the key debate is whether the theory could work in practice, rather than whether the theory holds. In terms of modelling, I think it would be hard to quantify the benefits as the variables (in particular: (1) the cost of downsizing and then re-scaling an organisation, and (2) change in marginal CPLSE with respect to a change in GDP) are inherently difficult to measure. Do you have any thoughts about how we could do it?
From a personal point of view, iff my utility curve is linear (i.e. losing 50% of my wealth would have a similar magnitude of utility change as gaining 50% additional wealth) and I know my date of death, then it would make sense to invest for as long as return on capital remains below GDP growth. I would be careful about saying “most market actors use a value of δ that’s too high” because I think you can argue what they are doing is perfectly rational; if you’re not sure if you’ll reach retirement, you’ll be less inclined to contribute to a pension (from a purely selfish point of view). Now we as altruists don’t have to worry about the date of death because we are helping a pool of people into the future, who don’t have to be alive today. However, we do have to worry about utility. To achieve the return on capital, we do need to take on risk. In general, wealthier people are able to take more risks than poorer people (utility functions are more linear at higher wealth). Altruists represent these poorer people (this point is more relevant to global health and development than animal welfare and long-term future), so should be sensitive to undiversifiable risks. In other words, I don’t think it’s obvious that we should be more patient (I’m talking in general terms, not about the specifics of economic conditions right now).
You can divide δ into (1) r or real risk-free rate and (2) - ηg or (beta * MRP). My subjective view is that the risk-free rate is too low and the MRP is too high. I think very few people think about their investments in the right way: “What level of return am I willing to accept to compensate me for volatility with standard deviation of x% (typically around 20% for the stock market)?”. Most people subscribe to: “I’ll do x% equities, y% corporate bonds and z% government bonds because that’s what everybody else is doing”. I personally invest 100% in equities for this reason. Furthermore, people are not flexible in how they behave (if you are familiar with the IS-LM model, I’m basically saying IS is steeply negative). In today’s investment environment, everyone should be spending a lot more (including on charity) and saving a lot less, but that’s not how people behave in practice. This is the reason why the real risk-free rate is so negative at the moment. Either way, the consequence is that you have to ‘pay’ a lot for a risk-free rate. Typically your money will grow not too different from inflation (and currently less) if you are not prepared to take any risk.
Finally, I do think value drift and diminishing marginal returns are very important points. Value drift is major simply because the world changes so fast. And in terms of diminishing marginal returns, I think the most important thing is that what we do today impacts the future. When you deworm a child, that’s not just an “expense” for benefits in that year, it potentially improves their school performance and stimulates economic growth. I prefer to think of it as “investment”. I think it’s much more important to build out a safe framework for AI now than try doing it in 100 years’ time (even with more resources).
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.
Thanks for your comment.
I’m not advocating it because of the fiscal multiplier. That would be the cherry on the cake.
The first simple step is simply to say don’t cut back expenditure because shrinking and regrowing an organisation is costly. Most charities (though EA ones are somewhat atypical) see their income reduced during bad times. And since most charities think in bland terms of x months of reserves, this means their expenditure fluctuates as well. This is an not efficient way to manage an organisation. In good times, build a buffer, so you can keep going during bad times. Just keeping expenditure flat would be a major step in the right direction.
Of course you can take it a step further. There is another cost argument, which is that it is cheaper to do stuff during bad times. When unemployment is high, you can get talented people more easily. So even if the benefits are the same, the benefit/cost is higher. The fact the benefits may be higher, not just that the fiscal multiplier may be higher, but that fulfillment of basic human needs may be worse, is a bonus, though it probably only applies to Global Health and Development causes. I wouldn’t use a Keynesian altruism strategy simply for this.
That’s a very interesting point I hadn’t considered. Yes, if the expenditure is in emerging markets, your money likely goes even further during global recessions
Really interesting article. Just one quick question: does high emotional stability mean low neuroticism?
Thanks for writing this article. I think you are spot on that many non-profit and for-profit organisations do not manage cash effectively.
A few comments:
The 2.16% doesn’t seem to me like a lower bound on interest if it’s in a bank account. If you invest in bonds, even short-term, you are exposed to capital fluctuations, so while it’s probably a good idea, it’s not a like-for-like comparison
The 5.51% return is unlikely going forwards. The last 20 years has seen unprecedented use of QE and a lowering & flattening of yield curves. I would assume equities return 5% p.a. and investment grade bonds 1% p.a. in real terms. The lowering of interest rates means (1) asset prices go up (so historical returns look better) and (2) future return expectations go down (across all assets)
Is GiveWell’s year end 31st Dec? The cash balance may be artificially higher at that point due to large number of donations in December
Great to have another person putting effort into making the world more altruistic and more effective!
I like the idea.
In terms of comment, I have two thoughts, both of which I think you have already thought about above. Firstly I think when creating a new organisation, you have to make sure you are creating something for which (1) there is a need and (2) there is not somebody already trying to meet that need already. At EA for Christians, we’ve found a need for two things: (a) thinking around how compatible EA is with Christianity (tl;dr it very much is), and (b) outreach to Christians who are not yet EAs. We make sure we don’t redo things the community already does.
Secondly, make sure the organisation is run by the right people. At first this normally means people who have volunteer time, but as it builds make sure you build the appropriate skills and experience. Typically the person who has an idea and the most suitable person to be CEO are not the same person, but most EA organisations are run by the founder.
Wishing you all the best with the venture!
I’ve written a post about why stepping up expenditure during a difficult time is often the correct thing to do here. I also talk about how I think the view of “let’s wait and things will be easier in the future” is flawed.
Great guide!
For company formations, you can also do them easily direct at Companies House. The only downside is you can’t hide your address.
I’ve also had a good experience with Revolut, which can do a multicurrency account and similar FX fees to Wise.
10^24 population expectation seems like the key assumption here. It’s easy to get that wrong by several orders of magnitude. All other assumptions are irrelevant if you assume that.
I was attracted to EA several years ago and delighted to have finally found people who share my desire to make the world a better place. I, like many others I have met since, was struggling to know how to do that most effectively. For me, the goal of EA should always be to make the world a better place and the way to do this is not to create a cult where you have to be in the core to be valued.
EA needs a blend of people. It needs some people identifying effective activities. It needs some people doing those effective activities. It needs some people funding those effective activities. And it needs some people trying to drum up other people to do those things. The people who earn-to-give to these activities will not be counted by you as ‘core’, but are as necessary as the other people.