Supplementing Private Foundations With a DAF
January 2025
It feels good to have a rainy-day fund – a little something in the coffers to dip into when times are tough. These funds can be safely stashed away, left untouched until needed. Most individuals and institutions have some ability to choose how much to spend versus how much to save. If you, as an individual, spend less than you earn, you are saving into a rain-day fund. For public charities, there are ways to smooth out required spending to provide future flexibility. Private foundations, however, have historically lacked significant input into the spend versus save decision. Private foundations are required to spend at least 5% of their average annual assets1, rain or shine. In years where portfolio returns are not sufficient to support spending without dipping into principal, the foundation has two options: 1) continue to distribute 5%, perhaps providing less community support than in prior years; or 2) spend more than 5% to provide consistent support, thereby reducing the portfolio value further which can create a vicious downward spiral of market value.
What if there was a way to create a rainy-day fund to help smooth and provide consistency in the foundation’s ability to support its causes? Enter the Donor Advised Fund, or DAF.
When a foundation contributes to a DAF as part of its annual spend, control of the assets is effectively transferred away from the foundation to the DAF. However, the foundation will provide the DAF with guidance on the investment and spending of the assets.
A DAF offers several different features that differ from private foundations, including:
• No minimum spending requirements
• Ability to easily transfer appreciated assets
• No recipient disclosure requirements, although recipient must be a public or private charity
The absence of a spending requirement for a DAF can be used to create ballast for the foundation’s portfolio.
Consider the following scenario:
• The DAF receives initial funding from the foundation. This funding is invested parallel to the foundation portfolio.
• In the same initial year, the foundation determines how much spending it would like to target annually. For example, they may take prior year spending and increase it by inflation.
• In years where the 5% minimum spend based on the portfolio’s value from the foundation is greater than the spending target, the excess will be allocated to the DAF.
• In years where the 5% minimum spend from the foundation is less than the spending target, the DAF will be used to fund the difference.
Ideally, the outcome would be as follows:
• The foundation reliably knows its annual spend and can plan accordingly.
• The DAF is funded during strong investment cycles and provides funding during weaker markets.
• Despite fluctuations in the portfolio’s value, the foundation can continue to provide consistent support to the community even when facing a challenging market – which is often when those funds are needed most.
• As the DAF continues to grow, the rate of spending increases can accelerate.
The “rainy-day fund” effect can be seen in the hypothetical illustration below:
Of course, this strategy works perfectly when we have perfect hindsight. However, the strategy also has levers that allow it to operate in different market environments. In a worst-case scenario, the foundation could continue to spend 5% of both the foundation and the DAF, leaving it no worse off than it was without the DAF. In a best-case scenario, the foundation, DAF, and associated spending would gradually outpace the growth and spending out of the traditional private foundation.
While this concept may appear novel and even complex, large private foundations have been utilizing this strategy for years. It is not going to be right for every scenario, but if you are interested in evaluating whether a DAF may be the right complement for your private foundation reach out to your Cornerstone advisor.
¹ We use 5% here without differentiating between true payouts, qualifying operating expenses, etc. as an example.
This report was prepared by Cornerstone Advisors Asset Management, LLC / Cornerstone Institutional Investors, LLC and reflects the current opinion of the firm, which may change without further notice. This report is for informational purposes only and is not intended to replace the advice of a qualified professional. Nothing contained herein should be considered as investment advice or a recommendation or solicitation for the purchase or sale of any security or other investment. Opinions contained herein should not be interpreted as a forecast of future events or a guarantee of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for a client’s portfolio. Economic factors, market conditions, and investment strategies will affect the performance of any portfolio and there are no assurances that it will match or outperform any particular benchmark. Investors cannot invest directly in an index. Commentary regarding the returns for investment indices and categories do not reflect the performance of Cornerstone Advisors Asset Management, LLC / Cornerstone Institutional Investors, LLC, or its clients. Historical performance results for investment indices and/or categories generally do not reflect the deduction of transaction and/or custodial charges or the deduction of an investment-management fee, the incurrence of which would have the effect of decreasing historical performance results. Figures contained herein are obtained from sources deemed reliable, but we do not guarantee its accuracy or completeness. Past performance is no guarantee of future results. Investments fluctuate in value. Securities Offered Through M Holdings Securities, Inc. A Registered Broker/Dealer, Member FINRA/SIPC. Investment Advisory Services are offered through Cornerstone Advisors Asset Management, LLC. Cornerstone Advisors Asset Management, LLC and Cornerstone Institutional Investors, LLC are independently owned and operated. 7466115.1
