Investment Assumptions (Yet Again!)

When we at PG Calc run long-term projections for charitable remainder trusts using our Planned Giving Manager (PGM) and PGM Anywhere software, we make certain assumptions about the investment performance of the trust assets. There is a fairly basic dynamic implicit in our modeling, which is that the remainder of the gift plan will be the result of the original funding amount, the amount paid out to one or more beneficiaries, and the amount earned by the trust assets. The default assumptions in PGM and PGM Anywhere are that of an 8% total investment rate of return, broken down into 5% principal appreciation and 3% income.

Determining Rate of Return

Some gift planning professionals, as well as specialists in closely-related fields, have asked whether the 8% total return assumption is overly optimistic. There is reliable data in the public domain upon which to base such assumptions. Perhaps the most widely-quoted measurements are the S&P 500 stock index and the Dow Jones Industrial Average stock index. Both indices experienced phenomenal performance in 2017, as did all of the major stock indices in 2017 (some as high as 25%). However, the mantra when projecting investment returns is “past performance does not guarantee future results.”

If we look at the long-term results of major U.S. stock indices, we see average annual performance of around 7% at the low end to solid double digits on the upper end; the specific numbers depend upon the index selected and the range of years measured. But those numbers are not the only numbers we should be looking at. In addition to the performance of stocks, gift planners and allied professionals should also be considering the long-term performance of bond indices.

Why do we say that? Because the assets of a typical charitable remainder trust are going to be invested in a combination of stocks and bonds. The prudent investor standard calls for the fiduciary (the trustee or other responsible party) to exercise caution in selecting investments, and to balance the needs of the current and future beneficiaries.

When we look at the long-term investment performance of major U.S. bond indices, the average annual rate of return runs much lower than the returns on stock indices, but nevertheless, these indices show consistent positive returns on a year-to-year basis. In the big picture, we should look at long-term performance of both stocks and bonds to come up with an estimate of future investment results. The so-called “balanced portfolio” will be a reasonable combination of stocks and bonds to produce a healthy return of income and growth.

Guidance from Asset Managers

And yet, there is another area of consideration that is as important as using an appropriate mix of asset classes, and that is the guidance of the potential trustee or investment manager. We’ve said it before, but it cannot be stated too many times: before the gift planner or allied professional undertakes a process of projecting the future results of a split interest gift arrangement, it is paramount to gather basic information about the likely management of the investment process. Who will be managing the assets if the trust is created?

Every asset manager has his or her own investment style. Any manager working in the not-for-profit sphere should be able and willing to provide basic information about historical investment returns and general assumptions to be used for future projections. We all understand that it is impossible to know exactly what is going to happen with investments in the future (i.e. past performance does not guarantee future results), but we should be able to use reasonable data that is available to us in the modeling of long-term outcomes for split interest gift arrangements.

Projecting Long-Term Outcomes

When a donor approaches you about a potential charitable remainder trust and the situation calls for a projection of the long-term outcome, you should proceed with a strict course of action. The first question you should ask is, who will be the asset manager, and then, you should consult that party for their projected asset allocation and investment performance before attempting to run any calculations. The information provided by the asset manager can then be modeled in PGM or PGM Anywhere, replacing the default investment assumptions. Not following this course of action may land you in the unenviable position of trying to explain original calculations at a later point in time, when the actual results point to a vastly different investment style that precluded any possibility of matching donor expectations.

We hope this piece helps you to think about the process of modeling projections for split interest gift arrangements. What are your thoughts on this topic? We would love to hear from you!