Diversification by Speculation

by Daniel Cross, ChFC

There is a naughty word whispered occasionally among investors. It has been heard in homes, jobs, and golf courses across America and equally met with fear and derision. A cold shiver runs down the spine of many an investor that hears it spoken aloud. The word is: speculation.

It has been demonized in the mainstream media, but speculation belongs in every investor’s portfolio whether you’re an aggressive day trader, decades away from retirement or a conservative, income-based retiree. The mere mention of speculating in a retiree’s portfolio is enough to send many financial planners sputtering in outrage and disbelief, but a fundamental understanding of what a truly diversified portfolio is and what it’s supposed to do should shed some light on this shadowy subject.

To understand speculation’s place in a portfolio, one must first define what diversification really means. To many investors, it means to have a mixture of equities and fixed income products to mitigate risk. This idea is an oversimplification that doesn’t take into account the various characteristics of a single investment such as beta, market cap, industry, and many other factors. The ideal portfolio would have a mixture of all of these from a basic savings account to an emerging markets fund. The point is that no single investment should carry a disproportioned weight that can swing a portfolio’s profits or losses solely by its performance.

While there is a negative stigma associated with the more speculative investments, most people overlook the possible defensive capabilities this can have. For the aggressive investor, speculating in atypical investments such as art, hedge funds, limited partnerships, and real estate can provide significant downside protection as many such investments are not directly related to stock market performance. Market fluctuations and even recessions can be effectively hedged using this strategy.

For the conservative investor, the benefits of speculation are not so readily apparent. The primary risk associated with these portfolios is underperformance. Fixed income based portfolios often struggle to keep up with inflation, especially during long bull market periods where it can rise dramatically like it did in the eighties. Keeping a portion of your portfolio in equities, emerging markets funds, and high-income corporate bonds (also known as junk bonds) can help you keep up with inflation much better.

Speculation also serves an ancillary role by keeping investors interested in their own accounts. Putting money into investments you believe in such as green energy, or pharmaceuticals will keep your attention on your money much better than just sticking it into a couple of random mutual funds and forgetting about it. Noted CNBC personality Jim Cramer is an advocate of this. He speaks of speculation as a way of “keeping you in the game” to help investors stay focused on their goals and monitor their overall portfolios and thus avoid the nasty surprises that afflict the unwary.

Used wisely, speculation serves an important purpose in any investment portfolio. By obeying the rules of diversification, you can use it to balance your investments and keeps you on the road to your ultimate goals. Keep all this in mind, and the next time you hear someone mention speculators, you can proudly say you’re one of them.

Of course, that was before the money dried up.

The longtime head of Harvard Management Company, Jack Meyer, quit to start his own hedge fund in 2005 after growing fed up with criticism over the eight-figure salaries some of his managers were pulling down and with persistent meddling from top Harvard officials. Two particular annoyances were Summers, who had been questioning Meyer’s investment strategies, and Robert Rubin, a member of the Harvard Corporation, who frowned on Meyer’s aggressive strategies and wound up on the “warpath” with Meyer, as one person put it.

• When Meyer left, he took much of Harvard Management Company with him — including 30 portfolio managers and traders, as well as the chief risk officer, chief operating officer, and chief technology officer. The place became “like a Ferrari without the engine,” according to a portfolio manager who arrived after Meyer left. This angered Rubin, according to someone who knows him well: “In Rubin’s opinion, Meyer crippled the institution.”
More…

One of President Ronald Reagan’s favorite expressions, which he often used in his negotiations with the old Soviet Union, was “Trust—But Verify.” Today, that expression may very well need to be turned on its head. Since World War II, general levels of trust—in each other, in business, and in government institutions—have steadily declined. Today, trust has reached a low ebb due to the near-collapse of the banking system, the self-interested behavior on the part of some corporate executives, and a host of other scandals such as the forced resignations of the governors of two major states.
A recent survey, the Edelman Trust Barometer, found that only 38% of Americans trust corporations to “do the right thing,” down from 58% last year. Lack of trust has in fact become pervasive. It used to be that you could trust personal recommendations from friends, but the Bernie Madoff Ponzi scheme, which was founded on recommendations from trusted friends and advisors, has put even that type of referral in doubt. The assurance of a friend who says a broker, lawyer, or doctor is outstanding may no longer be enough in the post-Madoff world. On a different level, a recent Wall Street Journal article about bank overdraft fees (which average $26/item) quoted one customer as saying, “I don’t trust my bank to resist the temptation to rip me off.”
Despite its vast transparency, the Internet presents its own trust-related issues. The New York Times, for example, recently highlighted a well-known health web site that asks visitors to fill out a personal health survey. Unknown to the participants, however, their personal information is then shared with pharmaceutical companies, who target them with tailored marketing pitches for drugs.
Finally, our ability to trust has also been undermined by puffery—by the equivalent of grade inflation in public life. Everyone is “the world’s leading authority,” a best selling author, or the inventor of a new product “based on a Nobel prize winner’s theories”—as touted by one recent TV advertisement.
Nothing is as it seems—or so it seems. The problem is that, as the 4th century monk and religious philosopher St. Augustine wrote in his essay On Lying, “When regard for the truth is even slightly weakened, all things remain in doubt.”
So how do you rebuild and strengthen trust in your professional relationships with colleagues, clients, and other constituencies? And as individuals, how can we know when to trust? Let’s look at these two separate but related issues that have been brought into relief by the calamitous events of the last 18 months.
The Heart of Trust
What is trust based on? Author Robert Shaw proposes that trust is “A belief that those on whom we depend will meet our expectations of them.” There are several core ingredients of trust:
1. Integrity: Is the person honest, reliable, and consistent? Can they discern between right and wrong? Is their behavior “integral” and consistently aligned with a set of core values and beliefs?
2. Competence: Is the other party competent to do the job at hand? I might trust my family doctor to treat the flu, for example, but certainly not to operate on my knee. In the business world, competence and credibility are important elements of our willingness to trust.
3. Agenda Orientation: Is the person focused on my agenda or on his agenda? Will they act consistently in my interests or in their own interests?
One of the CEOs I interviewed for my new book, All for One, expressed this to me in slightly different words. He said, “I wish all of my advisors were independently wealthy. Then, I would know that they would be objective, put my interests first, and always tell me what they honestly thought.
What enables us to judge integrity, competence, and agenda orientation is transparency. “What you see is what you get” summarizes this simple idea. When things are hidden (like bank overdraft fees that are only explained in too-small-to-read print), or only partially revealed (such as the intelligence about weapons of mass destruction before the US invasion of Iraq), it becomes difficult to trust. When vested interests and conflicts of interest are not properly disclosed—for example when a pharmaceutical company has paid a doctor for her research on the effectiveness of their drug—trust is undermined.
Increasing Trust in Your Relationships
To build trust in today’s environment, you have to exemplify behaviors that reinforce the foundations of trust. For example, you can:
· Do things that are clearly in the other person’s interest and not yours. You might turn down a piece of business with a customer, for example, because you are not the absolute best person for the job.
· Demonstrate your competence not through smooth proclamations (“trust us!”) but rather multiple testimonials from past clients and customers and specific examples of your successes. I call this showing rather than telling.
· Strengthen trust—or rebuild it if it has been damaged—through small, specific, confidence-building measures. Say you’re going to do something next week, do it, and then move on to the next step.
· Be available and present for your clients even when there aren’t a lot of fees coming in. Everyone talks about becoming a “trusted advisor”—real ones are not just mercenaries, they are helpful to others through thick and thin.
· Be extraordinarily transparent in your business relationships. Create a collaborative process to develop a proposal rather than writing it at your office and then “pitching” the client. Invite clients to see your operations and the processes your use to develop and deliver your solutions. Use collaboration technology and Web 2.0 platforms to create links with your clients and business partners and promote idea exchanges (this is what IBM does through its “Innovation Jams” which can involve over 100,000 employees, customers, and other partners).
Verifying Whom You Can Trust
Building trust in a low-trust environment is one challenge; verifying whom you can trust is also important. Because of hidden conflicts of interest, a lack of transparency, and the heightened risks of trusting in areas such as financial management, verification has taken on a heightened importance. “Trusting your gut” about someone is no longer the litmus test—and in any event, your gut can often be wrong because of the way some people (like sociopaths) can compartmentalize their personalities and appear credible.
Using the elements of trust described earlier, you need to ask a lot of hard questions before throwing your hat in the ring with someone. For example, you need to:
1. Verify Integrity. Do they have an unblemished track record of honesty and ethical behavior? These things can be verified using everything from multiple references (not one) to criminal background checks. Are their any inconsistencies in the information presented by this person and in their behavior? Even small things can be a tip-off—for example, an excellent job candidate once told me he had an MBA from a top Business School. However, it turned out it was an executive MBA, which was a very different kettle of fish from the school’s highly competitive two-year program (the executive MBA was far less competitive and took a fraction of the time to complete). Not a huge red flag, but a red flag nonetheless. In the case of Bernie Madoff, some investors turned down the opportunity to invest in his fund when very basic research showed that his trading system couldn’t possibly function the way he said it did.
2. Verify Competence. Can you objectively verify if the person or their company is really as good as they say they are? You could gain this insight by have in-depth discussions with at least several existing clients or customers. What is the quality of their business base? What level are they actually working at in the companies they list as references? People throw a lot of names around, but it’s one thing to work with a Senior Vice President at GE, and quite another to have a mid-level training manager at that company as your top client.
3. Verify their Agenda Orientation. Whose interests they are focused on? This is a judgment call you have to make based on having several in-depth conversations with the person. Are they sincerely focused on understanding your issues, or do they try to “close the sale” as fast as possible? Is their approach generic, or tailored based on having invested time to get to know you? Are they “pitching you” or trying to educate you about what they do and how they do it? You can also understand this by asking other clients or business associates about their relationship after the sale. Was the same level of enthusiasm present a year later? Did this person come through in a crisis or during a rough patch in the relationship?
Finally, how transparent are they? Is this person free and open with information about themselves and their organization? Do they advertise anonymous testimonials, or are their testimonials from real people with names and titles? Are they willing to give you three or four references? If you sense a cloak of secrecy, or an unwillingness to open up, then caveat emptor.
Another CEO that I interviewed for my research told me, “When someone says ‘trust me’ I usually reach for my wallet to make sure it is still there.” When it comes to trust, watch their feet, not their mouths. Look for inconsistencies, and carefully verify.

**************
Andrew Sobel is a leading authority on client relationships and the skills and strategies required to earn enduring client loyalty. Andrew is the author of the newly published All for One: 10 Strategies for Building Trusted Client Partnerships (John Wiley & Sons) as well as the business bestsellers Clients for Life and Making Rain. He has also written over 75 articles on building long-term relationships, and contributed chapters to four books on leadership, strategy, and marketing. He spent 15 years at Gemini Consulting, where he was a Senior Vice President and Country Head, and for 13 years he has headed his own consulting firm, Andrew Sobel Advisors. He can be reached at www.andrewsobel.com.

With over 77,000 Votes, St. Jude Children’s Research Hospital(R) Wins $797,123

MINNEAPOLIS, May 26 /PRNewswire/ — In just two short weeks, St. Jude Children’s Research Hospital(R) tallied 26.6% of total votes, coming in first winning $797,123 in the first-ever Target giving campaign on Facebook(R). Bullseye Gives, which kicked-off on May 10 and concluded on May 25, 2009, invited Facebook users to visit www.Facebook.com/Target to help Target decide how to divvy up $3 million among ten national charities. With more than 3,000 wall posts* from inspired voters, the campaign also created a place for the online community to share their personal stories and experiences.

With 291,399 votes tallied, Target will donate a portion of the $3 million amount to each charity based on their percentage of votes, which included:

— St. Jude Children’s Research Hospital – 77,427 votes (26.6%) =
$797,123
— American Red Cross – 77,118 votes (26.5%) = $793,942
— The Salvation Army – 38,004 votes (13%) = $391,258
— Operation Gratitude – 22,627 votes (7.8%) = $232,948
— Breast Cancer Research Foundation – 19,264 votes (6.6%) = $198,326
— Feeding America – 15,574 votes (5.3%) = $160,336
— HandsOn Network/Points of Light Institute – 11,378 votes (4.0%) =
$120,845
— Parent Teacher Association – 10,904 votes (3.7%) = $112,259
— National Park Foundation – 9553 votes (3.3%) = $98,350

— Kids In Need Foundation – 9,190 votes (3.2%) = $94,613

“On behalf of our patients and families, a heartfelt thank you to Target and the thousands of Facebook members who voted for St. Jude Children’s Research Hospital during the Bullseye Gives campaign,” said David L. McKee, chief operating officer and interim CEO of ALSAC, the fundraising organization of St. Jude. “This remarkable program gave the online community a simple way to provide much-needed funds to many worthy causes. We are humbled by the incredible show of support for our lifesaving mission.”

Funds raised through the Bullseye Gives campaign will support the groundbreaking research and lifesaving care at St. Jude, including the St. Jude School Program. For children undergoing treatment, school can offer a familiar and reassuring routine. In addition, school helps patients maintain a sense of identity, hope for the future and most importantly educational parity with their peers back home. With this in mind, the St. Jude School Program offers several services to assist patients with their academic progress while they undergo treatment at St. Jude. The St. Jude School Program is accredited as a Special Purpose School by the Southern Association of Colleges and Schools.

During the two-week campaign, Bullseye Gives generated incredible results and voter response, including:

— Target Facebook Page added 97,091 new fans
— During the campaign, the Target Facebook Page increased daily views by
4,800%*
— Target Facebook Page experienced a 3,000% surge in wall posts, with
more than 3,000 personal stories shared throughout the campaign*
— More than 167,000 fans on Facebook voted for the charity of their
choice

— St. Jude Children’s Research Hospital and American Red Cross received
over 53% of total votes

“We’re grateful to the online community for their passionate response to Bullseye Gives and their willingness to share personal stories about why these charities are important to them. We’re excited that all ten amazing charities will receive a generous donation, as well as increased awareness through social networking platforms,” said Laysha Ward, president of community relations, Target. “The voices of the online community reinforce that giving to those who need it most is a nationwide priority. We encourage the more than 167,000 voters to continue their support of these organizations or other worthy causes.”

As part of company’s continued commitment to service, Target offered to connect all Bullseye Gives participants with local volunteer opportunities through a partnership with VolunteerMatch, an organization that offers an array of programs to support community and civic service 365 days a year. Over 2,200 fans on Facebook clicked through to the VolunteerMatch service page to find causes and volunteer programs in their local communities.

Since 1946, Target has given 5 percent of the company’s income to support education, social services, the arts, and volunteerism. Today, that 5 percent adds up to more than $3 million every week. For more information on Target giving, visit www.Target.com/community.

About Target

Minneapolis-based Target Corporation (NYSE:TGT) serves guests at 1,699 stores in 49 states nationwide and at Target.com. Target is committed to providing a fun and convenient shopping experience with access to unique and highly differentiated products at affordable prices. Since 1946, the corporation has given 5 percent of its income through community grants and programs like Take Charge of Education. Today, that giving equals more than $3 million a week.

Facebook(R) is a registered trademark of Facebook Inc.

* As of May 22, 2009

Contact: Kristen Dinisio Jones
IMRE
410-821-8220

Target Communications
612-696-3400

Visit the Target Pressroom: Target.com/pressroom

Source: Target Corporation

CONTACT: Kristen Dinisio Jones of IMRE, +1-410-821-8220; or Target
Communications, +1-612-696-3400

Web Site: http://www.target.com/

For more on the budget, mathematics and political visualizations, follow me on Twitter: @PoliticalMath

Selling your business outright
You can sell your business outright, choosing the right time to sell—now, at your retirement, at your death, or anytime in between. The sale proceeds can be used to maintain your lifestyle, or to pay estate taxes. As long as the price is at least equal to the full fair market value of the business, the sale will not be subject to gift taxes. But, if the sale occurs before your death, it may result in capital gains tax.

Transferring your business with a buy-sell agreement
A buy-sell is a legally binding contract that establishes when, to whom, and at what price you can sell your interest in a business. A typical buy-sell allows the business itself or any co-owners the opportunity to purchase your interest in the business at a predetermined price. This can help avoid future adverse consequences, such as disruption of operations, entity dissolution, or business liquidation that might result in the event of your sudden incapacity or death. A buy-sell can also minimize the possibility that the business will fall into the hands of outsiders.
The ability to fix the purchase price as the taxable value of your business interest makes a buy-sell agreement especially useful in estate planning. Agreeing to a purchase price can minimize the possibility of unfair treatment to your heirs. And, if your death is the triggering event, the IRS’ acceptance of this price as the taxable value can help minimize estate taxes.
Additionally, because funding for buy-sells is typically arranged when the buy-sell is executed, you’re able to ensure that funds will be available when needed, providing your estate with liquidity that may be needed for expenses and taxes.

How a buy-sell agreement works
First: Buy-sell is established with a separate agreement or is created by including buy-sell provisions in a business’ operating agreement. Second: The plan is generally funded in some manner. Third: Upon a triggering event (as defined in the agreement), an owner’s interest is purchased by either the business itself or the other owners. Price is determined according to the terms of the agreement.

Gifting your business
If you’re like many business owners, you’d prefer to have your children inherit the result of all your years of hard work and success. Of course, you can bequeath your business in your will, but transferring your business during your lifetime has many additional personal and tax benefits. By gifting the business over time, you can hand over the reins gradually as your offspring become better able to control and manage the business on their own, and you can minimize gift and estate taxes.

Gifting your business using trusts
You can make gifts outright or use a trust. You can even structure a trust so that you keep control of the business for as long as you want. You can establish a revocable trust, which will bypass probate and allow you to change your mind and end the trust, or an irrevocable trust, such as a grantor retained annuity trust (GRAT) or a grantor retained unitrust (GRUT) that can provide you with income for a specified period of time and move your business out of your estate at a discount.

Gifting your business using a family limited partnership
You can transfer your business interest using another entity, such as a family limited partnership (FLP). An FLP is a limited partnership formed to manage and control a family business. You (and your spouse) can be the general partners, retaining control of the business itself and receiving income from the business, while your children can be limited partners. By transferring the business to an FLP, you may be able to use valuation discounts and substantially reduce the value of the business for tax purposes by making annual gifts to the limited partners.
Common business succession planning objectives are to ensure smooth, seamless transfer of ownership; transfer business to next generations; ensure business continuity; retire with an income source and minimize gift and estate taxes. The key is to pick the best plan for your circumstances and objectives, and to seek help from financial and legal advisors to carry out this plan.

Chris Toomey is a senior financial advisor for Weaver and Tidwell Financial Advisors. He can be reached at ctoomey@wtadvisors.com or by calling 832-320-3493.

Favorable Interest Rates

Interest rates are at historic lows and all indications are that they will be this way for a while. These low rates make some loan-based estate planning practices extremely advantageous.

Sales to Intentionally Defective Irrevocable Trusts (IDITs)

When assets are sold to an IDIT in exchange for an installment note, the interest rate on the note is based upon the appropriate AFR (Applicable Federal Rate) in effect at the time the note is created. The lower the AFR used, the greater the likelihood that rate of return on the assets owned by the IDIT will outperform the interest rate charged. In other words, if assets sold to the IDIT appreciate at a rate greater than the interest rate charged, there will be more assets left in the IDIT after the note is repaid.

Intra-Family Loan Arrangements

When funds are loaned by one family member to another, the adequacy of the interest rate charged on the loan is determined by the appropriate AFR. The lower the AFR used, the greater the chance that loaned money (assuming it is invested) will outperform the interest rate on the loan.

Life Insurance Loan Arrangements

When money is loaned by an insured to an Irrevocable Life Insurance Trust (ILIT) to enable the ILIT to pay life insurance premiums, the adequacy of the interest rate charged is again determined by the appropriate AFR. The lower the AFR used, the lower the gift tax cost of loaning money to an ILIT to make life insurance premiums payments (assuming the interest is imputed or gifted directly to the ILIT).

The favorable interest rate environment also benefits the Internal Revenue Code Section 7520 rate (7520 Rate) which is used in certain estate freeze techniques (i.e. freezing the value of your estate). The 7520 Rate is 2.4% for May, 2009, which is considerably less than the average 7520 Rate of 6.4% over the past 18 year period starting January, 1991.

A low 7520 Rate also makes estate tax freeze techniques, such as grantor retained annuity trusts (GRATs) and charitable lead annuity and unitrusts (CLATs & CLUTs) more attractive. Just like the techniques discussed above, the lower the 7520 Rate, the easier it is for a GRAT, CLAT or CLUT to outperform the expected return and therefore pass more money to younger family members estate and gift tax free.

Depressed Asset Values

In a recent post to my estate planning blog, Altman Speaks, I discussed the importance of reviewing your estate plan in light of declining asset values. Generally speaking, no one likes to see their assets lose value. However, the upside to such an occurrence is that gifting assets of lesser value lowers the amount of taxes that will be paid on the gift. In the future, the value of the gift may increase (outside of the client’s estate) and benefit the heirs.

Potential Legislation Eliminating Valuation Discounts

If planning is done properly, current law generally permits as much as a 35% to 50% discount when clients transfer certain types of assets. These discounts are generally applicable to transfers of interests in Family Limited Partnerships (FLPs), Limited Liability Companies (LLCs), etc., due to the lack of control and/or lack of marketability.

There is a looming threat to the ability to take sizable valuation discounts. House bill H.R. 436, introduced in early 2009 by Congressman Earl Pomeroy (D-ND), would eliminate the minority discount for transfers to family members, when family members, as a group, control the entity.

This bill also eliminates discounts for transfers of entities that hold non-business assets, such as bonds, stocks or cash.

Assuming H.R. 436 (or similar legislation) is enacted, the loss of the ability to take a discount for lack of control or lack of marketability will, in most cases, lead to higher valuation of assets, and thus higher estate and gift tax consequences. Clients who do not want to risk losing the benefit of higher valuation discounts might consider transferring their FLP interests, LLC interests, etc. prior to the potential enactment of any legislation.

The Triple Opportunity

In combination, these three occurrences (lower interest rates, depressed asset values and possibly legislation limiting valuation discounts) can create great opportunities for wealthy individuals to make the most of estate planning techniques and maximize the potential of gifts.

Possibilities include:

· Contribute depressed assets to an FLP;

· Gift an interest in the FLP to a family member or trust for a family member; and

· Give the FLP interest to a long-term GRAT or sell the FLP interest in an IDIT

Bottom Line:

The opportunity for clients to take advantage of this “estate planning triple witching hour” may be short-lived.

· There is no telling how long this favorable interest rate environment will last.

· Asset values hopefully will not remain depressed at their current level for too long, as a market upturn could be just around the corner.

· Legislation limiting valuation discounts may be passed before the end of 2009, though no one knows exactly what Congress will do.

· The “estate planning triple witching hour” is a reason to act now to transfer assets and wealth to younger family members.

Gary Altman, Esq. is founder of the DC Metro-area estate planning law firm, Altman & Associates, and the former President of the Financial Planning Association of the National Capital Area. He has been honored as a “Top 100 Attorney” in the country by Worth Magazine and has been recognized by Washingtonian Magazine as among the DC region’s “Best Estate Planners”. He can be reached on 301-468-3220 or via email at gary@altmanassociates.net. To learn more, visit www.altmanassociates.net.

The global financial crisis is creating severe hardships for individuals and reducing government budgets for relief. The crisis has placed great stress on nonprofit organizations and reduced the assets of both philanthropists and foundations. How should grant makers respond?

First, we need to stay focused on the commitments and long-term strategies we have already adopted. Whether we are working to improve the life chances of disadvantaged children, mitigate the catastrophic consequences of climate change, or alleviate poverty in Africa, these problems will be with us over many economic cycles. They can be solved only through perseverance, and this argues against switching directions just to address short-term crises. That doesn’t entail being hard-hearted toward those in immediate need, but does require some hard thinking about the consequences of diverting significant attention and resources from long-term goals.

Second, as unpleasant as it may sound, we need to recognize that the stress on nonprofit organizations provides opportunities for efficiencies and consolidations. Unproductive groups feel little pressure to change their practices in flush times. This is a time for some sorting out. So while we all want to help strong nonprofits weather the current crisis, it’s a time to consider redirecting money from marginal organizations to ensure the survival of high-performing ones.

Third, we must think strategically about how to deal with the decline in our own assets. The variables in our control include how much of our assets we spend to make grants and cover our administrative expenses.

Most foundations design their budgets so they will distribute 5 percent of their assets. Although that is the minimum percentage required by the Internal Revenue Service, many foundations treat it as a ceiling, as if their primary goal were perpetuity rather than solving social and environmental problems.

Restricting payout to 5 percent should not be sacrosanct. The real question for foundations is whether they will make more of a difference to society by spending now or husbanding resources for the future.

The answer may be different depending on the problems we seek to solve. Grant makers that focus their money on perennial causes, such as education and the arts, may find that distributing 5 percent of assets is just right. But in realms such as global warming or nuclear proliferation, where prevention is vastly cheaper than cure, spending only the minimum now may be wildly counterproductive.

Then there is the question of administrative expenses. Our job in managing foundations is to spend money effectively. Lavish internal budgets, oversized staffs, and self-indulgent processes work against this. But the opposite extreme is also counter-productive.

Our ultimate goal is to achieve our missions most effectively, and this is not cost-free. If we didn’t care about impact, we could easily give away our philanthropic capital in one day[--]even Bill Gates and Warren Buffett could.

Giving money effectively, especially for complex causes or to aid distant countries, requires an expert staff, great skills in getting to know people working on the ground, and strong intelligence networks. Maintaining a staff and other administrative expenses are justified so far as they help achieve our social missions. We should use this time to check and see how much of our administrative budgets are adding to the quality of the foundation’s work and how much might be trimmed.

Our bottom line: in periods of financial stress, don’t lose sight of your fundamental goals and strategies, and make sure that your assets are deployed to achieve them most effectively.

————————————-

Paul Brest and Hal Harvey are the authors of Money Well Spent: A Strategic Plan for Smart Philanthropy (Bloomberg Press 2008). Brest is the president of the William and Flora Hewlett Foundation and Harvey is president of ClimateWorks Foundation.

Drawing on examples from more than one hundred foundations and not-for-profits,
Money Well Spent gives readers the framework they need to design a smart strategy, addressing such key issues as:

§ Effective use of tools—education, science, direct services, advocacy—that can achieve your objectives
§ How to choose the forms of funding to achieve stated goals
§ How to measure the impact of grants or programs
§ When to be patient and stick with a winning strategy and when to abandon a strategy that isn’t working

This is a book for everyone who wants to get the most from a philanthropic dollar: donors, foundations, and not-for-profits.

Examples of strategic philanthropic successes included in
Money Well Spent by Paul Brest and Hal Harvey are:

§ Ploughshares Fund, whose mission was quite large—preventing the use of weapons of mass destruction—used its $4-million-per-year budget to make a principal contribution to the International Campaign to Ban Landmines, helped renegotiate the Nuclear Nonproliferation Treaty, and also supported high-level, off-the-record negotiations between senior U.S. analysts and North Korean officials that may have averted a war during the Clinton administration.

§ The F. B. Heron Foundation, which focuses on asset building in low-income communities, notes that its core support grants are evaluated on the basis of the grantees’ planning documents, and the foundation thus measures progress in terms of the organizations’ own ambitions and plans.

§ The Abdul Latif Jameel Poverty Action Lab (J-PAL), a research center at MIT, specializes in conducting random controlled studies in developing countries. For example, J-PAL randomly assigned girls in Kenya either to a group that was promised merit-based scholarships and cash grants for school supplies if they scored well on academic exams, or to a control group. Just being eligible for scholarships led the girls to think of themselves as “good students” and led to higher academic grades. Both student and teacher attendance improved, and even boys showed improvement in their test scores.

The U.S. Charitable Sector: A Snapshot, 2007**
Approximately 1.4 million nonprofits are registered with the IRS.
The nonprofit sector of the economy accounts for 5.2% of GDP.
The nonprofit sector is responsible for 8.3% of the salaries and wages paid in the U.S.
In 2005, individuals, foundations, and corporations gave $260 billion in donations to nonprofits. In 2005, 25% of Americans, 65 million people, volunteered their time to nonprofits.
In 2004, the 1.4 million nonprofits received around $1.4 trillion in revenue
and controlled $3 trillion in assets.
1,400 nonprofits have assets over $500,000,000.
263,200 nonprofits have assets over $1,000,000.

# # #

Hal Harvey, left, and
Paul Brest, right

Photo: John Storey

About the Authors of Money Well Spent

Paul Brest is the president of The William and Flora Hewlett Foundation. Before joining the Hewlett Foundation, he was a professor at Stanford Law School, serving as dean from 1987 to 1999. He teaches a course on judgment and decision making in the Public Policy Program at Stanford University and is coauthor of the forthcoming book Problem Solving, Decision Making, and Professional Judgment.

Hal Harvey, a former director of The Hewlett Foundation’s Environment Program, is now the president of ClimateWorks. He is also the president of the New-Land Foundation and has held positions at several different not-for-profit foundations, including the Mertz-Gilmore Foundation, the Heinz Endowments, and the Ploughshares Fund.

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Participation in qualified retirement plans, such as 401(k)s or some other form of a defined-contribution plan, has always been a mixed bag. Often, despite considerable efforts from companies, participation rates among rank-and-file workers fall well below expectations. When this happens, it obviously jeopardizes future retirement-living standards for those workers. A less obvious consequence is the constraints this situation puts on future retirement incomes for senior executives.
How can low retirement-plan participation among rank-and-file workers impact future retirement for senior managers? Qualified retirement plans, which are tax-deferred, operate under federally mandated nondiscrimination rules, which govern the amount highly compensated employees can contribute to their qualified plan based on overall participation levels. An additional restriction is the annual compensation limit imposed on these plans. For 2008, the compensation limit is $230,000. For an employee under 50, this means the maximum total contribution—regardless of participation levels or actual income level—is 20 percent of $230,000, or $46,000. Of that, the employee’s maximum portion of the contribution is $15,500. For those over age 50, the maximum is increased by $5,000.
Advance planning provides remedies

Given these restrictions, particularly for companies where retirement-plan participation is low, finding additional ways to provide higher retirement income for senior executives can be important for recruiting and retention purposes. It takes good planning, but there are several options available. Generally, they include:

· boosting overall retirement plan enrollment
· creating specific types of qualified retirement plans
· offering exclusive supplemental retirement and compensation plans (SERPS)

Boosting overall retirement plan enrollment helps increase the amounts senior executives are allowed to contribute, but it can be difficult to convince rank-and-file employees to begin contributing to these plans. Some workers do not believe they can afford to defer a percentage of their current income to contribute to their future retirement. Others procrastinate or simply do not understand enough about the program, so they resist enrolling.

To build participation, some companies have increased communication, created promotions and even made significant changes to their plans, such as faster, simpler applications and automatic enrollment. For plans with automatic enrollment, employees must opt out, which means natural procrastination tendencies work in favor of increased plan participation. Increasing enrollment, however, is often not enough to fully compensate senior managers.

Creating specific types of qualified retirement plans is another option. Some companies create safe-harbor 401(k) plans, which offer automatic contributions in accordance with specific federal guidelines. Plans meeting these guidelines are able to sidestep nondiscrimination tests, which allow all eligible employees, including senior management, to maximize their contributions.
Employee eligibility and contribution requirements for safe harbor 401(k) plans are the same as for other 401(k) plans, with one exception. In these plans an employer is required to make a 100 percent vested contribution for each employee or a matching contribution that adheres to federal requirements. There are several ways to structure these plans but they must provide all employees with an equal employer contribution.
For some companies with collectively and non-collectively bargained employees, separate qualified retirement plans are an option. Creating two plans tends to group highly compensated employees together, which decreases the likelihood that senior executives would face restriction on their contributions.
While these plan options may help, the annual limits on contributions to tax-deferred plans may still be inadequate for some highly compensated employees.
The final option, exclusive supplemental retirement and compensation plans, or SERPS, provides the most flexibility. Companies are not required to provide these benefits to all employees, so they can offer senior managers additional retirement compensation though this approach. SERPS are variously designed, but many offer some combination of elective compensation deferrals, various stock options, stock bonus plans or stock appreciation rights (SARS). SARS are an obligation to provide compensation, generally based on the value of a company’s stock, at a particular point in time, such as retirement. Non-qualified benefits are not protected from creditors, however, which mean senior managers could become creditors in a bankruptcy proceeding, for example, and potentially lose these benefits.
Often non-qualified compensation plans are associated with “rabbi trusts,” which are agreements between an employee and employer for payment at a specified future time. Nondiscrimination rules to not apply to rabbi trusts, so they can be provided exclusively to certain employees and, properly structured, they allow income tax deferrals for the employee.
Other compensation typically offered to highly compensated employees include various “perks,” such as tax preparation services, paid legal work or financial planning or any number of other benefits. However, these perks generally do not directly contribute to retirement.

Providing appropriate retirement compensation for highly paid senior managers does take planning, but it is often necessary to retain top talent.

Alan Goldfarb is director of Financial Strategies for Weaver and Tidwell Financial Advisors Ltd. (www.wtadvisors.com) in Dallas, Texas. A Certified Financial Planning practitioner, Goldfarb has been named Top Financial Advisor by Worth magazine six times. He holds an MBA in economics and management from the University of North Texas and a bachelor’s degree in engineering and management from Fairleigh Dickinson University. He can be reached 972-960-1100.