Donor-Advised Funds vs. Taxable Accounts for Patient Donors

Confidence: Likely

A donor-advised fund (DAF) is an investment account that allows donors to take a tax deduction now and give the money to charity later. When you put money into a DAF, you can deduct it just as you would deduct charitable contributions. Then you can direct the DAF on how to invest the money, and choose to donate it whenever you want.

If you want to invest to give later, DAFs have some clear advantages, plus some limitations. Is it better to use a DAF, or to keep your money in an ordinary (taxable) investment account?

According to the assumptions made in this essay:

  • If I want to invest in a portfolio of stocks and bonds, then I should use a DAF.
  • If I have the ability to use leverage or to invest in assets with low correlation to stocks and bonds, then I should keep my money in a taxable account.

Disclaimer: I am not an investment advisor or a tax advisor. Nothing in this post should be construed as investment advice or tax advice. This content is for informational purposes only. Please do your own research or seek professional advice and otherwise take reasonable precautions before making any significant investment or tax decisions.

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The Risk of Concentrating Wealth in a Single Asset

Some people hold most or all of their wealth in a single asset. A few examples of common situations where people do this:

  • Alice works at Google. A large chunk of her compensation comes in the form of Google stock.
  • Bob bought bitcoin a few years ago and the price went up a lot. Now, bitcoin accounts for 50% of his net worth.
  • Carol used her retirement money to buy a second house, and she earns income by renting it out.

This is usually a bad idea, and you should go to great lengths to avoid it. It’s bad even if you have high risk tolerance, because you can get a better expected return by building a diversified portfolio and then adding leverage.

Key points

  • On average, an individual stock provides the same expected return as the total stock market, but with 2-3 times as much risk. You could apply leverage to a total stock market index and get 2-3 times the expected return for the same level of risk as an individual stock. Or you could add leverage to the global market portfolio and get 3-4 times the expected return. [More]
  • The same principle applies to other types of individual assets, such as private company stock, rental properties, and cryptocurrency. [More]
  • If you hold a lot of money in a single asset and want to diversify, you may have to pay capital gains tax when you sell. The diversification benefits probably overcome the tax hit after about 3-10 years. [More]
  • You can reduce taxes by donating to charity, or by putting the money in a donor-advised fund or a foundation. [More]
  • If you’re a major stakeholder in an asset, you might depress the price by selling. You can reduce your market impact by selling slowly, or by paying your broker to manage the sale for you. [More]
  • An exception: Altruistic investors don’t just care about their own investments, but about the overall altruistic portfolio. If you hold an individual asset that other altruists can’t hold, such as equity in a private company, it might make sense to keep it. [More]

Note: In this essay, I make some illustrations using historical market data. Future market behavior will probably look different, so the exact numbers I use won’t apply. But I expect the basic principles to remain true in the future.

Disclaimer: I am not an investment advisor and this should not be taken as investment advice. Past performance does not indicate future results. This content is for informational purposes only. Please do your own research or seek professional advice and otherwise take reasonable precautions before making any significant investment decisions.

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"Disappointing Futures" Might Be As Important As Existential Risks

Confidence: Possible

Summary

  • Perhaps the most concerning risk to civilization is that we continue to exist for millennia and nothing particularly bad happens, but that we never come close to achieving our potential—that is, we end up in a “disappointing future.” [More]
  • A disappointing future might occur if, for example: we never leave the solar system; wild animal suffering continues; or we never saturate the universe with maximally flourishing beings. [More]
  • In comparison to civilization’s potential, a disappointing future would be nearly as bad as an existential catastrophe (and possibly worse).
  • We can make several plausible arguments for why disappointing futures might occur. [More]
  • According to a survey of quantitative predictions, disappointing futures appear roughly as likely as existential catastrophes. [More]
  • Preventing disappointing futures seems less tractable than reducing existential risk, but there are some things we might be able to do. [More]
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Mission Hedging via Momentum Investing

Disclaimer: I am not an investment advisor and this should not be taken as investment advice. This content is for informational purposes only. Please do your own research or seek professional advice and otherwise take reasonable precautions before making any significant investment decisions.

Confidence: Likely1

Hauke Hillebrandt explains mission hedging:2

How should a foundation whose only mission is to prevent dangerous climate change invest their endowment? Surprisingly, in order to maximize expected utility, it might use ‘mission hedging’ investment principles and invest in fossil fuel stocks. This way it has more money to give to organisations that combat climate change when more fossil fuels are burned, fossil fuel stocks go up and climate change will get particularly bad. When fewer fossil fuels are burnt and fossil fuels stocks go down - the foundation will have less money, but it does not need the money as much.

But mission hedging has a big downside: it reduces diversification, which hurts your risk-adjusted return.

The momentum premium: “stocks with low returns over the last year tend to have low returns for the next few months and stocks with high past returns tend to have high future returns.”3 Investors can take advantage of the momentum premium by buying stocks that have gone up recently. The evidence suggests that it has persistently worked in nearly every financial market in the world, and there is a reasonable expectation that it will continue to work in the future.

In addition, momentum investing might provide effective mission hedging.

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Giving Now vs. Later for Existential Risk: An Initial Approach

Summary

  • This essay presents a variety of simple models on giving now vs. later for existential risk.
  • On the whole, these models do not strongly favor either option. Giving now looks better under certain plausible assumptions, and giving later looks better under others.
    • On the simplest possible model with no movement growth and no external actors, giving later looks better.
    • Higher movement growth/external spending pushes more in favor of giving now.
    • If our efforts can only temporarily reduce x-risk, we should spend a proportion of our budget in each period, rather than spending or saving all of it.
  • It has been argued that, because philanthropists are more patient than most actors, they should give later. This argument does not necessarily work for existential risk.
  • The probability of extinction has relatively little effect on when to give.
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Should We Prioritize Long-Term Existential Risk?

Cross-posted to the Effective Altruism Forum.

Summary: We should reduce existential risk in the long term, not merely over the next century. We might best do this by developing longtermist institutions1 that will operate to keep existential risk persistently low.

Confidence: Unlikely

This essay was inspired by a blog post and paper2 by Tom Sittler on long-term existential risk.

Civilization could continue to exist for billions (or even trillions) of years. To achieve our full potential, we must avoid existential catastrophe not just this century, but in all centuries to come. Most work on x-risk focuses on near-term risks, and might not do much to help over long time horizons. Longtermist institutional reform could ensure civilization continues to prioritize x-risk reduction well into the future.

This argument depends on three key assumptions, which I will justify in this essay:

  1. The long-term probability of existential catastrophe matters more than the short-term probability.
  2. Most efforts to reduce x-risk will probably only have an effect on the short term.
  3. Longtermist institutional reform has a better chance of permanently reducing x-risk.
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The Importance of Unknown Existential Risks

Summary: The most dangerous existential risks appear to be the ones that we only became aware of recently. As technology advances, new existential risks appear. Extrapolating this trend, there might exist even worse risks that we haven’t discovered yet.

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Estimating the Philanthropic Discount Rate

Cross-posted to the Effective Altruism Forum.

Summary

  • How we should spend our philanthropic resources over time depends on how much we discount the future. A higher discount rate means we should spend more now; a lower discount rate tells us to spend less now and more later.
  • We (probably) should not assign less moral value to future beings, but we should still discount the future based on the possibility of extinction, expropriation, value drift, or changes in philanthropic opportunities.
  • According to the Ramsey model, if we estimate the discount rate based on those four factors, that tells us how quickly we should consume our resources1.
  • We can decrease the discount rate, most notably by reducing existential risk and guarding against value drift. We still have a lot to learn about the best ways to do this.
  • According to a simple model, improving our estimate of the discount rate might be the top effective altruist priority.
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Do Theoretical Models Accurately Predict Optimal Leverage?

Summary

Previously, we talked about how much leverage altruists should use. We looked at estimates of optimal leverage based on future projected returns, but this required making certain assumptions about how asset prices behave.

In many ways, theoretical asset pricing models do not reflect how investments behave in practice. These models may overestimate how much leverage to use. We can learn something about the extent of this overestimation by backtesting leveraged portfolios on historical price data.

In the backtests I performed, theoretically-optimal leverage according to the Samuelson share usually did not differ much from empirically optimal leverage according to backtests. However, the Samuelson share overestimated optimal leverage more often than it underestimated, and following the Samuelson share would have occasionally resulted in bankruptcy.

After performing this analysis, I am now somewhat more confident that it makes sense for altruists to apply substantial leverage to their altruistic portfolios, although probably less than the Samuelson share. However, investors should ensure they understand what that entails—in backtests, optimally-leveraged portfolios usually encountered >90% drawdowns at some points.

Disclaimer: I am not an investment advisor and this should not be taken as investment advice. This content is for informational purposes only. Please do your own research or seek professional advice and otherwise take reasonable precautions before making any significant investment decisions. Any given portfolio results are hypothetical and do not represent returns achieved by an actual investor.

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How Much Leverage Should Altruists Use?

Cross-posted to the Effective Altruism Forum.

Last updated 2020-05-17.

Summary

Philanthropic investors probably have greater risk tolerance than self-interested ones. Altruists can use leverage—borrowing money to invest—to increase the expected utility of their portfolios. They may wish to lever their portfolios at much higher ratios than self-interested investors—likely 2:1 to 3:1, and perhaps much higher (practical concerns notwithstanding).

Unlike normal investors, altruists care about reducing their correlations with other investors, so they should heavily tilt their portfolios toward uncorrelated assets.

This essay will discuss:

  1. Traditional vs. altruistic investing
  2. Basic arguments for using leverage
  3. Appropriate levels of risk for altruists
  4. The importance of uncorrelated assets, and where investors might be able to find them
  5. Potential changes for philanthropic behavior

Disclaimer: I am not an investment advisor and this should not be taken as investment advice. This content is for informational purposes only. Please do your own research or seek professional advice and otherwise take reasonable precautions before making any significant investment decisions. Any given portfolio results are hypothetical and do not represent returns achieved by an actual investor.

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