The Compounded Cost of Over-Conservatism: A Guide for Trustees, Directors and Committee Members

by David Knowles, Head of Philanthropy & Social Capital, Partner, Koda Capital

Introduction

This paper is the third in a series dedicated to helping trustees, directors and investment committee members of Australian charitable, non-profit and philanthropic organisations (‘nonprofits’) think more clearly about some of the common, yet less obvious investing risks they face as non-profit investors.

Most non-profit investment committees are highly attuned to one form of risk: the risk of losing money. It is the risk that is most visible, most immediately felt, and most likely to attract criticism. It is the worry that keeps people up at night and shapes investment decisions around the boardroom table. For that reason, it is also the risk that most often drives non-profits towards cash and term deposits.

But there is another risk. One that rarely features in the same conversation. And that is the risk of being too conservative, in a manner that is unnecessary and consequently costly over time. It is the risk that an organisation’s approach to asset management, in seeking safety above all else, quietly snd persistently fails to generate the returns needed to maintain the organisation’s real purchasing power over time. This is a risk that does not announce itself with a dramatic fall in asset value. It arrives gradually, through the compounding gap between what an organisation earns and what it needs to sustain its work.

This paper makes the case that both risks deserve attention. It is not an argument for recklessness, nor a suggestion that all non-profit portfolios should embrace volatility or move too far up the risk curve. It is a call for balance, perspective and genuine engagement with the full picture of risk, including the kind that compounds quietly in the background while a committee or board focuses on more visible concerns. It is ultimately about avoiding the risk of significant opportunity cost.

We hope this paper prompts useful reflection and, where needed, a considered conversation about what prudent stewardship of non-profit assets really requires over the long term.

Understanding Risk from Both Sides

If you have taken up the challenge of investing money on behalf of a non-profit, you will be familiar with the weight of responsibility that comes with it. You are entrusted with safeguarding assets for the benefit of others. The desire to protect what has been built, often through generous donations or years of careful accumulation, is natural and appropriate.

This protective instinct typically manifests as a preference for conservative investments. Cash accounts, term deposits, and high-quality bonds feel safe. They provide certainty of income and preservation of capital in nominal terms. For many non-profit investment committees, this feels like the prudent path and it often is. It is also the one least likely to expose the organisation, its beneficiaries, or committee members to criticism or loss. Prudent risk management is not just appropriate for non-profit investors – it is a core part of their fiduciary duty, and one that Koda takes seriously.

But here is the flip-side: while the risk of losing money through volatile and risk-bearing investments is visible and often discussed by boards and committees, the risk of being too conservative is often overlooked. This risk is inherently less obvious. It manifests not through visible losses, but through the silent erosion of purchasing power and the gradual diminution of an organisation’s capacity to achieve its mission. Both risks are real and both must be actively managed.

People who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value

Warren Buffett

The Hidden Risk of ‘Playing it Safe’

When we hold assets in cash or term deposits over the long term, we expose ourselves to inflation risk. Consider $10 million in surplus funds invested in term deposits earning 4%. After ten years, assuming the interest is spent to support programs, the capital remains at $10 million. With capital intact and income funding programs, this looks like prudent stewardship.

But what has really happened? If inflation averaged 3% per annum over that decade, the real value of that $10 million has fallen to approximately $7.4 million in today’s purchasing power. The organisation now has 26% less capacity to fund its programs than it did ten years ago, even though no money was ‘lost’ in the traditional sense. Fig.1 below illustrates this scenario.

Compare the outcome illustrated in Fig.1 to one where the capital is invested in a manner that delivers a 7% return, 4% is spent and the remaining 3% is reinvested. After ten years, $4,585,553 has been produced for programs and the capital has grown from $10,000,000 to $13,439,164^.

This is not a theoretical issue. Many Australian non-profit organisations face cost inflation that exceeds CPI. Healthcare charities face medical cost inflation, educational non-profits face rising education costs, and social service providers face rising demand and wage growth pressures. For these organisations, a strategy focused solely on capital preservation in nominal terms carries a very real risk of capital erosion in real terms over time.

The mathematics of compounding work both ways. Just as investment returns compound to build wealth over time, the gap between conservative returns and what is needed to maintain purchasing power also compounds. A seemingly modest difference of 3% per annum in returns becomes a 34% difference in capital value over ten years, and an 81% difference over twenty years. These are not minor variations. They represent fundamentally different financial futures

The Fiduciary Duty to Consider Both Risks

Being a fiduciary means more than simply avoiding losses. It means making considered judgments about risk and return that serve the long-term interests of the organisation and its beneficiaries. This requires weighing different types of risk against each other.

There is no single right answer when it comes to investment risk and Koda does not advocate a one-size-fits-all approach. The appropriate level of risk varies considerably depending on factors including an organisation’s spending needs and timeframe, the stability of its other income sources and the nature of its obligations to funders and beneficiaries.

That said, for organisations with long-term investment horizons some allocation to growth assets may not just be appropriate, it may be essential to fulfilling fiduciary duties. Growth assets such as equities, property, and alternative investments have historically delivered returns that exceed inflation over the long term, albeit with greater short-term volatility.

The risk of volatility (that the value of investments may fluctuate over time) is real and must be actively managed. Trustees and directors are right to take it seriously, and a well-constructed portfolio should always reflect an organisation’s genuine risk capacity and tolerance. But board and committee members must also grapple with the risk of inadequacy – that available assets will fail to generate sufficient returns to maintain the organisation’s real purchasing power and capacity to achieve its mission over time.

Many investment committees focus almost exclusively on the former while giving insufficient attention to the latter. This is understandable. Volatility is visible and immediate. It is enough to produce an uncomfortable result in an annual report or financial statement. A 15% fall in portfolio value will be noticed, discussed and probably criticised. The gradual erosion of real purchasing power each year is invisible until years have passed and opportunities have been lost.

From a fiduciary perspective, both risks matter. Indeed, for organisations with long-term horizons, the compounding impact of over-conservatism may well represent the greater threat to mission achievement.

“Inflation is taxation without legislation.”

Milton Friedman

Making Better Decisions

The following ideas can help non-profits manage risk prudently, while avoiding opportunity cost:

Take the time to understand your organisation’s true risk tolerance and capacity. What would be the impact of a 20% fall in portfolio value? Could it be sustained if it recovered over 3-5 years? Conversely, what would be the impact of having 30-40% less real purchasing power in ten years?

Establish your organisation’s inflation profile and cashflow forecast. As far as practically possible, use this information to inform your asset allocation decisions and reflect it in your investment policy statement.

Segregate your assets to optimise returns without leaving yourself exposed. Separate funds into distinct categories: 1. Cash needed for operating expenses and essential expenditure, 2. Funds that can be invested to earn higher rates of interest without risking capital value, and 3. Surplus funds that can be invested into risk assets with potential for long-term capital growth as well as income.

Seek expert, truly impartial advice that is tailored to the non-profit context. The investment needs of a charitable endowment are different from those of a superannuation fund or a private investor. Work with advisers who understand these differences and can help you navigate them.

Establish a robust investment policy framework that explicitly addresses both downside risk and adequacy risk. Your policy should articulate how the organisation thinks about these competing risks and how it has struck the balance between them given its specific circumstances.

Adopt a long-term perspective in evaluating performance. Short-term volatility is the price investors pay for long-term growth. If your investment horizon is measured in years or decades, quarterly or even annual fluctuations should not drive fundamental strategy decisions.

Embrace ongoing education and reflection. Investment markets, the regulatory environment, and your organisation’s circumstances all evolve. What was appropriate three years ago may not be appropriate today. Regular review and genuine engagement with these questions is not just good practice – it is part of your fiduciary duty.

“An investment in knowledge pays the best interest.”
Benjamin Franklin

Conclusion

Investing on behalf of others involves understanding and balancing competing risks.

The fear of losing money is natural, understandable and entirely appropriate. Managing downside risk is a genuine and ongoing responsibility for every director, trustee and investment committee member. But that responsibility should not come at the cost of the organisation’s long-term capacity to serve its mission.

For many Australian non-profit organisations, the biggest threat to long-term mission achievement is not market volatility but the gradual erosion of purchasing power that comes from investment strategies that prioritise short-term comfort and perceived risk avoidance over long-term adequacy.

Being truly prudent means taking seriously both the risk of being too aggressive and the risk of being too conservative. It means recognising that sometimes the path that feels safest and most prudent may turn out to be the riskiest of all.

The ultimate measure of investment stewardship is not whether the portfolio avoids all volatility, but whether it provides the organisation with the resources it needs to achieve its mission, both today and decades into the future. When viewed through this lens, a thoughtfully constructed portfolio that includes growth assets is not reckless – for many organisations, it is the responsible choice.

Self-Reflection Questions

• Do you know how your organisation’s inflation rate compares to the Consumer Price Index? Might it be higher?
• Have you explicitly considered the risk that your investment returns might not keep pace with your organisation’s overall expenditure profile over the long term?
• Do you understand the real purchasing power of your organisation’s capital today compared to five or ten years ago?
• Does your investment policy address adequacy risk as well as volatility risk and risk of permanent capital loss?
• Are you making investment decisions based on what feels safe, or on what will best serve your organisation’s long-term mission?