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5 Questions to Ask When Choosing a Donor-Advised Fund

Don't overlook these important considerations when selecting a donor-advised fund for charitable contributions.

Donor-advised funds are an increasingly popular way to give to charity. In 2018, contributions to them reached a record $37 billion, according to the 2018 Donor-Advised Fund report from the National Philanthropic Trust, an independent public charity that offers its own donor-advised funds and also provides data on donor-advised fund asset flows industrywide.

One of the big things propelling the growth of donor-advised funds is how easy and convenient they are to use. Many of the larger ones, such as Fidelity Charitable, Schwab Charitable, and Vanguard Charitable, have user-friendly web solutions that make donating and granting easy. Donor-advised funds make things easy from a recordkeeping perspective, too, because even if you donate to multiple charities in a calendar year, the fund consolidates the receipts you would file with the IRS into one statement and one deduction amount.

- source: National Philanthropic Trust

They're also flexible in terms of the types of assets they will accept: stocks, bonds, and shares of mutual funds, as well as private equity, hedge funds interests, restricted stock, real estate, and bitcoin. And donating appreciated securities in-kind can maximize your charitable impact because capital gains taxes are eliminated, and the donor is allowed to take the tax deduction at market value rather than at the cost basis of the asset. (See "Is a Donor-Advised Fund Right for You?" for more.)

But that's not to say that donor-advised funds are the best way to make charitable donations. For one, there are account minimums and fees, which you wouldn't have to contend with if you were to give to charity directly. And even though you get an immediate tax deduction for contributing to a donor-advised account, you don't have to disburse the funds to charity right away. (In fact, the money can sit in the account indefinitely, which has led some to question whether the contributions are being used primarily as a tax benefit to the donor rather than for charitable purposes.)

Proponents of donor-advised funds believe that this flexibility--the ability to make donations to the account and receive immediate tax benefits for doing so while being allowed to disburse the money from the accounts according to your own timetable--is a benefit. Many like the idea of having a "philanthropic portfolio" that allows them to invest the money in the donor-advised account and ultimately compound their charitable impact.

Choosing a Donor-Advised Fund There are some important things to consider when choosing a fund. Answering these five questions can help you narrow the field.

1. What are the investment minimums? How much do you plan to contribute initially, and how much do you plan to give on an ongoing basis? Donor-advised funds differ in their minimum initial donations and their minimum ongoing contribution amounts. For instance, Schwab and Fidelity require a smaller minimum initial donation to set up the account, as well as smaller ongoing contributions. Vanguard's are significantly higher and may be out of some donors' reach.

2. How high are the ongoing administrative fees? The administrative fees, which are used to cover operating expenses and staff salaries, are charged in addition to the fees on the underlying investments. Though they are not onerous for the three donor-advised funds listed below, some will charge 1% of assets or higher on smaller balances. (In almost all cases, you'll end up paying more in percentage terms for accounts that have lower ongoing balances.)

3. Do the investments have reasonable costs? Because you're paying the expenses on the underlying investments in your donor-advised fund account in addition to any administrative fees you might be charged, make sure the investment lineup consists of solid investments with low costs. (Many times index funds can give you exposure to specific asset classes at an extremely low cost.)

4. Can you assemble a diversified portfolio from the investment options available? Determine whether you could build a well-diversified portfolio whose risk level matches your investment time horizon from the donor-advised fund's menu of investment choices.

Choosing a handful of funds with excellent trailing performance that have similar investing styles and significant overlap with each other won't give you the best investment results over time and in varying market environments. Rather, you can optimize your portfolio's risk/return by selecting combinations of investments and asset classes that are not perfectly correlated; such a combination of assets is likely to do reasonably well in a variety of environments because as one asset is falling, another is likely rising.

When comparing the single asset-class options at Fidelity Charitable, Schwab Charitable, and Vanguard Charitable, I think Schwab's is topnotch. Not only does it give investors access to ultracheap index funds across a wide range of asset classes (there's a Bloomberg Barclays US Aggregate Bond index tracker, a total U.S. stock market index tracker, a MSCI EAFE tracker, and an inflation-protected bond option), but it also includes some Morningstar Medalist-rated actively managed funds with exposure to high yield (Gold-rated Metropolitan West Total Return Bond MWTRX) and emerging-markets (Bronze-rated Hartford International Opportunities HAOYX).

Investors won't go too far wrong with Fidelity Charitable's lineup either, provided they keep portfolio diversification in mind. Fidelity Charitable's menu features actively managed options (both in-house and from other asset managers) and broad, reasonably priced Fidelity index funds. Some of the actively managed options can give investors exposure to some asset classes that aren't represented in the index offerings; for instance, Silver-rated T. Rowe Price Overseas Stock TROIX has exposure to emerging-markets equities, and Gold-rated PIMCO Total Return PTTRX and Gold-rated Fidelity Total Bond FTBFX provide exposure to high-yield bonds and Treasury Inflation-Protected Securities.

Vanguard Charitable's lineup is pretty sensible and covers most of the bases. Arguably, though, it would be more efficient for investors to get their international diversification through the broader international-stock index fund on the menu than the more narrowly focused regional options that are also offered. Further, the investment menu would be more well-rounded if it contained some exposure to asset classes that are not represented in broader index funds, such as high yield or an inflation hedge such as TIPS.

5. Can you get good diversification at a low price from the all-in-one portfolio offerings? If choosing investments and building portfolios isn't your thing, many donor-advised funds offer multi-asset investment options for donors who prefer an all-in-one, hands-off investing experience. These are diversified portfolios with fairly static asset allocations; when selecting one, consider your time frame and risk tolerance.

When comparing the asset-allocation investment options at Fidelity Charitable, Schwab Charitable, and Vanguard Charitable, Vanguard Charitable's are hard to beat. There are five investment pools from very conservative (cash equivalent and short-term bonds) to total equity for more-aggressive investors with longer time frames. All pools are made up of two to three topnotch funds (mostly index-trackers) and feature rock-bottom fees (15 basis points or less).

Fidelity's seven asset-allocation pools correspond to the seven funds in the Fidelity Asset Manager series, which vary in their aggressiveness by the percentage they allocate to equities. Although the funds do cover many bases--funds in the series have exposure to stocks (both domestic and foreign), bonds, and cash equivalents--Morningstar's manager research analysts rate the more equity-heavy funds Neutral as they judge the underlying equity strategies to be less inspiring than the bond strategies used by the funds. The more conservative bond-heavy strategies in the series rate Bronze. Also, the expenses, while not onerous, range from 0.53% to 0.73%; the higher the funds' annual fees, the less money you have to pay out to the charities.

The options in Schwab's preallocated pools are serviceable but not overly impressive. Schwab offers four preallocated investment tracks: conservative, balanced, socially responsible balanced, and growth. Like the Fidelity pools, they consist of one fund each. Schwab's preallocated pool also has an fund that focuses on environmental, social, and governance fund factors, Pax Balanced PAXWX, for sustainably minded investors. Fees on all four fund options are average to slightly above average relative to their peer group, ranging from 0.84% to 0.91%.

Some donor-advised funds (such as the three mentioned above) allow you to invest from both menus, which could be useful if you have more than one time horizon for grants. For example, you could have some money earmarked for a grant in the near future allocated to a conservative preallocated pool, while money you plan to gift further down the road is invested in a collection of more-aggressive strategies.

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