So it has been a while since establishing a Donor-Advised Fund (DAF) through Vanguard, and in the process I discovered a few techniques for harnessing these beasts that seem worthy of note. As for all things in life, if I’d known a bit more earlier, there would have been considerable gain/pain avoided, so perhaps others can learn a few things from this experience.

Týr learns a few things setting up his DAF (Bauer 1911)

DAFs are a great tool, so the opportunities for improvement are really more about refinements rather than a vicious critique; don’t let this commentary preclude you from advancing. Here are a few topics for consideration if you are contemplating a DAF:

  1. Looking further ahead – charge the “Converter”
  2. Looking further abroad
  3. Sandboxing your SWR

Looking further ahead – charge the “Converter”

In your 20s and 30s one may have higher priorities for directing your surplus funds – houses & spouses chief among them. But let’s say you had the good fortune to have some investments in your early going that have generated some capital gains. At the same time, you are a generous individual that is interested, for the sake of the well-being of the earth and your soul and body within it, in supporting various charitable organizations that are helping shape the vision of the world as you would like to see it. Donations to these appropriate 501(c)(3) organizations gives you a tax deduction as well, if you itemize.

Think of the DAF as a “Converter” you engineer to get more oomph from your donations. If instead of making these donations with cash or from your checking account, perhaps you channel appreciated stocks or mutual funds through the DAF and gain the advantage of avoiding taxes on the capital gains. You could then replenish the mutual funds from your checking account, increasing the cost basis and reducing taxes you will owe on them in the distant future.

Without such a Converter in place it is less easy to donate appreciated equities to charities. With it functional, it is easy and moreover you can “charge” the Converter in one time period to deliver powerful charitable blasts at times of your choosing.

2017 was a classic example of how having a DAF Converter in place already was advantageous. I’d set mine up in 2016. In late 2017 the U.S. tax code was revised to make itemizing deductions far less appealing for 2018 and beyond, so I “charged” my DAF by pulling in donations I might have made in 2018, doing so using appreciated mutual funds. This meant I took a larger deduction in that year. Having the DAF in place in 2017 allowed me to react swiftly and flexibly to the late-breaking changes in the tax code, and I did not need to decide then where to channel grants. Now here in 2018, I can target periodic donations from the DAF with more deliberation.

Just as a test of how simple making donations is, I’m a bit overdue for my first activity this year, so I logged in to my Vanguard Charitable account at 08:27. It took me twelve clicks and four minutes to target a charity (Nature Conservancy, local chapter) and send them a spring grant. For reference they say a talented video game (say a Korean Starcraft) player can perform over 300 actions per minute, so working that math out, a talented one could make about 25 donations per minute (DPM), were they so inclined. The DAF will then sit charged for some more action later this year – my basic plan is to distribute grants quarterly.

So how could my DAF have been improved? First, I would have gotten on board far, far earlier than my fifth decade. Having one in place in my 30s and 40s and channeling mutual funds through it would have added some % tax efficiency to my giving. It also would have been available for more years where tax brackets were high, the tax code was advantageous, and I had a mortgage/more often took itemized deductions. Better late than never, but setting one of these up sooner would have been beneficial.

Looking further abroad

Like many folks who follow financial independence stuff rabidly, I’m a big proponent of Vanguard. So when I set my DAF up, it was through them, and they offer a fine array of low-cost passive index funds and low administrative fees. Mentally I treat these as part of my total portfolio/new worth. Technically I cannot use them for my own modest expenses, but since I administer the distributions from the DAF it seems fair to consider them “assets under management.”

It is fair to point out that other firms such as Fidelity and Schwab currently offer lower initial setup amounts and donation amounts. For 2018 the minimums are shown in the below table:

One should consider the plan expenses and restrictions of any program (these or others) in light of your own preferences when considering whom to go with.  If the initial $25,000 is a daunting barrier for someone younger (and it certainly would have been for me), and/or if you prefer to make a lot of <$500 grants, then one of the others might be a better fit. I really did not give it as much thought as I could have, and while Vanguard suits me fine, ideally one should examine the options with more due diligence.

Sandboxing your SWR

For those interested in engineering a “perpetual money machine,” the topic of Safe Withdrawal Rates (SWR) comes up a lot. How much can you withdraw from your portfolio sustainably? In a similar fashion, you may be interested in setting up your DAF such that it generates recurring grants over the course of eternity. Managing a DAF in your midcareer might be considered a sandbox environment where you can practice asset allocation strategies and examine what SWR you feel comfortable with giving from your DAF while preserving much of its capital for sustained benefits and/or a legacy.

In the previous post I mentioned only about the 4% rule of thumb, but if you want to delve into other techniques, there is some interesting commentary and math on options out there, such as:

  • The basic 4% rule of thumb
  • a CAPE-based SWR – the Shiller PE ratio for the S&P 500 is around 32 currently, so with a=0.01, b=0.5, the SWR=2.56%. This would vary with market conditions.
  • 1/life expectancy, or variations on this based on the Bogleheads Variable Percentage Withdrawal rules. Let’s say a North American female of 40 is doing this, so with another great 45 years ahead, simply say 1/45=2.22%. This percentage would grow over time (sadly).

The table below summarizes some approaches and their impacts. Let’s say in January you calculate the SWR on a $25,000 balance as your plan for the year, as you would calculate your own annual expenses from your portfolio. With the total annual grant amount set, given certain minimums you can set up some grant frequency options.

Clearly you could reduce the frequency of the smaller grants if you prefer, or not give at all in a certain year or deplete the whole thing if you tire of it. The point is that the DAF is a sandbox where you can experiment with your “assets under management” to see what suits you the best psychologically. If you operate a DAF for many years before you transition to a lower income status, you will be educated and positioned more successfully for managing your other assets you will use to maintain yourself. Practice makes the master.

Conclusion

Ah, to have considered sooner these refinements on when and how to choose and manage a DAF. Another decade or two operating a tool such as this would have made me much wiser (a low bar). Perhaps a DAF will fit into your toolbox and suit your life goals at some appropriate time.