The past five years have been turbulent for many nonprofits. The fallout from the pandemic, inflation and other uncertainties has undermined their financial health and left some struggling to survive. A solid investment policy can help your organization weather such times more successfully.

Understanding investment policies

An investment policy is a blueprint for how to manage a nonprofit’s investments in light of its long-term goals and objectives. It delegates roles and responsibilities among board members, the investment committee (if applicable), staff, custodians and advisors. Effective investment policies are comprehensive but not overly complex. They lay out clear and understandable guidelines that are easily executed. In addition, they reduce the risk that nonprofit leaders will make ad hoc and unsystematic decisions in the heat of the moment.

Investment policies also help keep your investment strategies on track regardless of the market situation. As leadership evolves, they provide consistency that helps board members satisfy their fiduciary duties. Finally, they offer stakeholders reassurances about the organization’s financial stewardship and sustainability.

Getting started

When drafting an investment policy, your nonprofit must consider a wide range of factors, including the following:

Purpose. What is the purpose of the investments? Identify both short- and long-term purposes, such as predictable payouts, capital preservation, long-term growth and specific return on investment. If you have multiple investment portfolios, identify the purposes for each.

Investment target. Based on the purpose, you can set a target for your investment returns (including any management or administrative fees). Remember, too, to account for long-term inflation. Previously, it was reasonable to use a 2% to 3% figure for inflation, but you may want to raise this rate in light of recent inflation trends, and even to account for how factors such as climate change might affect prices in the not-so-distant future.

Risk appetite. How much risk is your nonprofit willing to accept to achieve its mission and objectives, bearing in mind the amounts required to sustain daily operations? This determination is based on:

• Your organization’s comfort level with short-term losses and volatility,
• The degree of diversification you desire,
• Any applicable regulations and restrictions,
• Required liquidity levels, and
• Time horizons.

Risk appetite generally is something that warrants discussion among the full board.

Investment choices. Nonprofits often have preferences about the types of investments they wish to pursue. For example, it’s increasingly common to take environmental, social and governance (ESG) considerations into account. Similarly, you may want to prohibit some investments. An environmental nonprofit, for instance, might want to avoid buying fossil fuel stocks. But prohibited investments should be defined narrowly so you don’t unintentionally handcuff your investment advisors.

Asset allocation. Your nonprofit’s investment portfolio generally should include a variety of asset classes, including equities (international and U.S.), fixed income (such as bonds and certificates of deposit), real estate, commodities, and private equity. Make sure your investment policy establishes target allocations for each asset class, as well as an acceptable range. Your policy also should include a rebalancing policy for when a class’s portfolio percentage goes above or below the acceptable range. How often will your organization check allocations and what amount of variance will trigger rebalancing?

Performance evaluation. Explain how you’ll objectively measure your portfolio’s performance. Set an overall portfolio benchmark based on asset allocation targets, along with separate benchmarks for individual asset classes and investments.

Living document

Developing an investment policy isn’t a one-off exercise. Your policy requires regular updating to reflect changes to your organization, the investing landscape and other factors. On the other hand, you want to avoid constant tweaking, as an investment policy is intended to provide a steady hand. In most circumstances, an annual review will strike the right balance.

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