It’s also astonishingly easy to start a charity. The Internal Revenue Service approves more than 99.5 percent of charitable applications, often in very short order. Because of this, the sector includes more than a few organizations that have little connection to common notions of doing good: the Sugar Bowl, the U.S. Golf Association, the Renegade Roller Derby team in Bend, Ore., and the All Colorado Beer Festival, just to name a few.
2. Donors should reward charities that have low overhead.
The notion that charities should put as much money as possible into services and as little as possible into overhead expenses is widely accepted. Overhead ratios, which measure the relationship between a charity’s income and expenses, are one factor in popular rating systems such as Charity Navigator and the Better Business Bureau’s Wise Giving Alliance. Charity Navigator, for example, suggests that administrative spending greater than 30 percent is unreasonable, and it rewards its highest ranking to organizations that put less than 15 percent of their resources toward such costs.
Low overhead has become a point of pride — and marketing — for charities such as the Brother’s Brother Foundation, a Pittsburgh-based relief organization whose Web site boasts that “less than 1% of the value of donations [is] used for overhead.”
But charities need to spend on research, training and financial systems, all classified as “overhead,” to be effective. Those that shortchange these investments — and many do — are less likely to achieve their goals. The American Red Cross, for instance, struggled during Hurricanes Katrina and Sandy in part because it hadn’t invested enough in the infrastructure necessary to handle complex emergency relief.
That lack of investment is partly due to public pressure, rather than a shortage of funding. When then-Red Cross chief executive Bernadine Healy tried to appropriate unused money from the 9/11 Liberty Fund to correct weaknesses in the group’s broader emergency response capacity, she was forced to resign.
3. Tax incentives are critical to charitable giving.
People with income in the lowest quintile give a higher percentage of their earnings to charity than do more wealthy Americans. This pattern persists despite the fact that low earners have less disposable income and rarely take advantage of itemized tax deductions for charitable donations. Sure, some contributions are tax-driven: Almost a quarter of online giving occurs in the last two days of the year as taxpayers rush to qualify for deductions. But Americans’ generosity may be more resistant to changes in the tax laws than most people think.
According to Congress’s Joint Committee on Taxation, the charitable tax deduction will cost the federal government $230 billion from 2010 to 2014. Some economists believe that charities would lose less than that amount if the exemption were eliminated or modified, since people give for many reasons unrelated to tax incentives. Because of the perceived unfairness and inefficiency of the current system, many analysts, including at the Congressional Budget Office, have begun to look at substantial changes, from establishing floors or ceilings for deductions (sometimes in combination with making incentives available to non-itemizers) all the way up to eliminating the deduction.
4. Nonprofits are not profitable.
In 2010, U.S. charities reported more than $2.7 trillion in assets. Even putting aside the multibillion-dollar endowments of Harvard and Yale universities, many lesser-known charities have substantial war chests. In 2007, Ascension Health, a large Midwest charity hospital chain, reported reserves of $7.4 billion, more than twice the cash on hand at the Walt Disney Co.
Some donors look for small, underfunded charities, thinking their gifts will make a bigger difference. But that is not necessarily an effective strategy. Many of the charities with strong track records in delivering results — organizations such as Youth Villages of Memphis and the Nature Conservancy — are also quite good at building financial reserves. Charities like these identify clear goals and have third parties evaluate their work, practices that are more important than how much they have in the bank.
5. It is easy to find a good charity to support.
In fact, it is enormously difficult. Not only is there considerable confusion among charities — for example, there are more than 60,000 with the word “veteran” in their names — there is little information on groups’ effectiveness. The mutual fund industry employs 159,000 people to help investors make good choices. But there are fewer than 100 people nationwide whose jobs are to help the giving public make wise donations. So what is a conscientious donor to do?
Put in the work. On average, Americans spend more time watching television in one day than they do researching charities in an entire year. Finding good charities takes time. It means using the few organizations, such as GiveWell, that do in-depth studies of charities’ effectiveness. And it means remembering that the best organizations, charitable or otherwise, are built on more than a good story or a charismatic leader.
As Warren Buffett once said: “I try to buy stock in businesses that are so wonderful that an idiot can run them. Because sooner or later, one will.” That’s good advice when trying to make sure donated dollars actually do good.
Read more from Outlook, friend us on Facebook, and follow us on Twitter.
Want to challenge everything you think you know? Visit Outlook’s “Five Myths” archive.