Quick Answer
A private foundation is a charity funded by a single major source (an individual, family, or corporation) and must distribute at least 5% of its non-charitable-use assets each year. A public charity draws broad public support and has no mandatory distribution minimum. Both invest their endowments to balance long-term growth against inflation and spending needs.
Foundations and charitable organizations are institutional clients whose distribution obligations and investment goals shape how their accounts are managed.
What Is a Private Foundation, and What Must It Distribute?
A private foundation is a tax-exempt charitable organization recognized under the Internal Revenue Code that uses an endowment to fund charitable activities.
Key characteristics:
- Typically has a single major funding source (an individual, family, or corporation) rather than broad public support
- Must distribute at least 5% of non-charitable-use assets annually for charitable purposes
Investment considerations for private foundations:
- Must balance long-term growth (to maintain the endowment's purchasing power) with the 5% annual distribution requirement
- Overly low-risk investments may fail to keep pace with inflation plus distributions, eroding the endowment over time
Exam Tip: Gotchas
The 5% minimum distribution rule is specific to private foundations. Public charities and other nonprofit organizations do not have this mandatory distribution requirement. The exam may try to trick you by applying the 5% rule to the wrong entity type.
What Are Charitable Organizations, and What Do They Invest For?
Charitable organizations operate for charitable, educational, religious, or scientific purposes and are generally tax-exempt.
- May receive tax-deductible donations from donors
- Investment goals typically focus on:
- Preserving purchasing power against inflation
- Generating income to fund operations and programs
- Meeting spending needs while maintaining the endowment for future use
| Concept | Private Foundation | Public Charity |
|---|---|---|
| Tax-exempt status | Yes (501(c)(3)) | Yes (501(c)(3)) |
| Funding source | Typically a single major source (individual/family) | Broad public support |
| Mandatory distribution | 5% of non-charitable-use assets annually | No mandatory minimum |
| Tax-deductible donations | Yes | Yes |
What Should an Adviser Consider When Investing Endowment Assets?
When advising foundations and charities, an adviser must consider:
- Spending rate vs. growth: The portfolio must generate enough return to cover distributions/spending while maintaining long-term purchasing power
- Inflation protection: Endowments are meant to last indefinitely, so the investment strategy must outpace inflation over time
- Liquidity needs: Foundations need enough liquid assets to meet annual distribution requirements; charities need liquidity for operational spending
- Risk tolerance: Generally moderate; aggressive strategies risk the endowment, while overly low-risk strategies risk purchasing power erosion
Exam Tip: Gotchas
- Endowment strategy is about balance, not maximizing return. An answer that recommends the most aggressive portfolio ignores the endowment's need to fund distributions and preserve purchasing power. The better answer is usually a moderate, diversified strategy.
Think of it this way: The fundamental challenge for endowment management is balancing the need to spend today with the obligation to preserve assets for the future. Spend too much now and the endowment shrinks; invest too cautiously and inflation eats away purchasing power over time.
What Should You Check on Exam Day?
- A private foundation must distribute at least 5% of non-charitable-use assets annually; a public charity has no such rule.
- A private foundation is funded by a single major source; a public charity draws broad public support.
- Both foundations and charities balance growth against inflation protection and liquidity needs; risk tolerance is generally moderate.