Follow the Money

It’s important to know how people get paid. Once you understand that, you can see how financial motivations affect their actions.

Last week I was speaking with an investment advisor who oversees the investments of wealthy clients, and I asked him how he and his colleagues feel when their clients take money out of their accounts to make a large charitable gift.

“We love it!” the investment advisor said. “It’s really a major reason why we do what we do. We help people accumulate wealth, and it makes us feel great to see it go out to a worthy cause.” In fact, he said that in 27 years in the business, he could only remember one time when a colleague of his was upset by a charitable gift.

I  think the investment advisor is guilty of selective memory, or perhaps even self-delusion. What he said is certainly not in alignment with my observations over the years.

Let’s begin by looking at how he and his colleagues get paid. Most investment companies calculate their compensation as a percentage of assets under management. Typically that number is around 1%. If the client has a million dollars of invested assets, the company’s annual fee is about $10,000, and the individual investment advisor’s take is a percentage of that. If the client has a hundred million dollars invested, then the company’s annual fee comes to around a million dollars.

Human nature and capitalism being what they are, investment advisors want to manage as much money as possible, so that their income is as large as possible. As I write this, I can well imagine investment advisors sputtering about the service they provide to their clients, and I’m not here to deny that or to disparage the profession. I’m only stating the obvious – that they take their compensation as a percentage of assets under management – and  this can’t help but influence their attitude toward charitable giving.

A mantra you hear (in my case, overhear – I’m sometimes at presentations designed for investment advisors) is that a key to their business success is “multi-generational asset management retention.” That is, investment advisors work with some very wealthy elderly clients. When these clients die and their kids inherit their fortune, it’s in the interest of the investment advisors to convince the next generation to keep their funds right where they are.

But what if Mom and Dad decide in their estate plan to give a million dollars to the local Boys and Girls Club? Well, that would mean that the investment advisor would lose a million dollars from his client portfolio, even if he convinced the kids to keep the rest of the family assets within the firm. That would mean reduced income for the company, and lower compensation for the investment advisor. Human nature drives the investment advisor to try to prevent that gift – or to divert it in a way that allows for both a charitable gift and asset management retention.

The advisors’ way of pulling off that trick is to convince their clients not to give the money away to the Boys and Girls Club or any other charity, but instead to create a private charitable foundation or to place the money in a donor-advised fund controlled by their firm. As part of their sales pitch they’ll talk about how in this way the clients’ names will live on forever as charitable leaders. They’ll talk about how the foundation or donor-advised fund will give the clients’ children and grandchildren a cause that will bring them together for years to come. They’ll talk about how the funds will support the community they all love a hundred years from now.

What they won’t talk about is how these assets will continue to be managed by the same company, thereby keeping fees and income flowing at the accustomed level.

Readers of this blog know that I think perpetual foundations are inefficient vehicles for serving the community and do little or nothing to narrow the wealth gap. You may also remember that I’m dubious about donor-advised funds getting money out where it’s needed and that I worry about an unfortunate trend where private foundations manipulate donor-advised funds to avoid accountability. Go ahead and accuse me of being a scold on the subject: I’m guilty as charged. But I can’t quite get away from this central challenge in the philanthropic world of so much fresh money going into private foundations and donor-advised funds.

So it’s important to understand some of the drivers for their continued popularity. Certainly the creation of a perpetual charitable fund plays to the founder’s ego. Certainly, too, the idea of getting a tax deduction now but retaining the ability to distribute the charitable benefit later is attractive to the donors.

But there’s another gravitational pull tugging at the donors: their advisors’ financial incentives. Lawyers get paid to draw up the foundation documents, and, sometimes, to serve on the board. Accountants get paid for filing the annual tax returns. And investment advisors receive a fee for managing the foundation’s assets – pretty much the same fee as if those funds were still officially part of the donor’s portfolio. I’m not saying that financial remuneration is the primary driver for all advisors in these situations, but we would be kidding ourselves if we didn’t think that it was a significant factor for many of them. And advisors play an important role in their clients’ decisions. To call the advisors’ motivations into question may be uncomfortable, but it’s a valid line of inquiry.

Meanwhile private foundations and donor-advised funds proliferate, while nonprofits that are desperate for donations lose out. And the investment advisors talk about how they are promoting charitable giving, while happily drawing their fee year after year.

Copyright Alan Cantor 2012. All rights reserved.

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2 Comments. Leave new

  • some advisors are wholistic enough in their thinking to support their client needs & wants to unleash capital to make a difference in the world in whatever form is best. We also balance clients capital and goals here & now with the future. A current year large gift, might restrict the the ability to make a difference on an important issue in the future. It’s all about balance. Thank you for the thought provoking post Al.

    Reply
    • Thanks for the comment, Alison. Always great to hear from you! Absolutely — advisors come in all stripes, and they respond differently. Certainly, you and your colleagues have a wonderful reputation for helping clients have real impact with both their investments and donations.

      And, yes, there’s a role for setting money aside for later charitable purposes, particularly if the client has just sold a business or otherwise registered a significant capital gain that makes a particularly large charitable gift attractive in a given tax year. It’s hard to distribute an extremely large pool of funds for charity in just one year. That said, too often I see perpetual charitable foundations or donor-advised funds as being the default solution in this situation. I think each case should be evaluated on its own merits — and in many cases, setting up a charitable fund or foundation and distributing all the assets over a five- or seven-year period has the most impact for the community — and, I’d argue, for the donors.

      Again, thanks! Keep reading — and commenting!

      Reply

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