Giving Compass' Take:

• For philanthropists to engage in smart and effective philanthropy, donors need to understand risk aversion and the necessity of risk-taking with charitable investments. 

• What are the ways that you take risks with your philanthropy? 

• Here are some benefits of taking more risks in philanthropy. 

Donors are often confused about the appropriate levels of social risk and reward they should target in their philanthropy. They tell us they should bring the same risk aversion to philanthropic decision making that they display in their personal investment decision making. This is wrong.

Risk aversion is sensible in personal investments because losing most of your money impairs your quality of life far more than you would benefit by increasing your net wealth by even a large amount.

The general point is that the marginal utility of additional wealth or consumption is diminishing. To see this, imagine how much pleasure you’ll get from eating a burger when you are really hungry. Then imagine how much incremental pleasure you’ll get from eating a second burger, and then a third and a fourth. How much more delight will you enjoy from that fourth burger after eating three? Not much.

Along similar lines, you may well prefer an investment that enables you to buy one burger for certain rather than one that offers a 50 percent chance of four burgers and a 50 percent chance of not being able to buy any burgers at all—even though on average the riskier investment buys twice as many burgers as the safe investment would. Economics captures this point by saying that diminishing marginal utility gives rise to risk aversion.

The connection between grantmaking strategy and endowment investment strategy may not be obvious, but the frameworks are surprisingly similar.

The major difference between personal and foundation investments is that the former finances personal consumption, while the latter finances welfare enhancements in the lives of others. The relative importance of return and risk are not generally the same in these two different contexts.

 

Read the full article about philanthropy involves taking more risks by Tanaya Jagtiani at India Development Review.