From the December 2008 issue of Wealth Manager Web • Subscribe!

December 1, 2008

DIVINING INTENT

Knowing your customers isn't critical for launching a business, but it comes in handy for staying solvent. But what about advising clients on philanthropy? How much do you really need to know about why a well-heeled individual chooses to give away a chunk of her assets? The answer--or answers--are debatable, in part because explaining selflessness is rarely simple.

Yes, altruism drives philanthropy. But what drives altruism? There are some obvious, if less than satisfying, responses starting with clich?s: "He's a generous guy," or "She wants to give something back to the community." There's also the religious angle. All the world's great religions embrace the Golden Rule. In the secular world, the so-called ethics of reciprocity has a long history, going back at least to Socrates.

The philosophy of charity towards one's neighbor is deeply embedded in cultural history, yet a broad consensus for explaining selfless acts in economic terms is still elusive. That hasn't stopped dismal scientists from trying. One of history's early efforts came in the 18th century via Adam Smith's The Theory of the Moral Sentiments, which claimed that morality is an instinct rather than a choice.

Defining charity--instinctive or not--in the modern era, philosopher Thomas Nagel forged a popular view of altruism as "a willingness to act in consideration of the interests of other persons, without the need of ulterior motives." Fair enough, but Nagel's description may be too lofty for some, including those who doubt the existence of true altruism. The act of giving, goes one line of thinking, may reflect a more complicated psychological process than Nagel's explanation allows.

On the surface, a donor can give without receiving anything in return--at least nothing tangible. An alternative view is that altruism reaps more subtle rewards, ranging from the satisfaction that comes from helping others to currying favor with the rich and powerful or improving one's standing in the community. Still another view is that guilt, consciously or unconsciously, may promote giving. Ayn Rand was a leading proponent of this idea. Guilt, she once wrote, "is altruism's stock in trade."

Perhaps it's safe to say that philanthropy's drivers are multi-faceted. In that case, fully explaining the motivations for giving may be impossible. As with love and hate, ambition and regret, altruism's fundamental sources can't be isolated with surgical precision as if we're decomposing the ingredients in a cake or analyzing the elements of wood or iron.

Does that limitation leave financial professionals at a disadvantage? How much detail does a wealth manager need to know for advising clients in their philanthropic ventures? Should an advisor take pains to understand why Mr. Jones wants to set up a foundation to help the poor? Or is it enough to simply know that he wants to help? How much inquiry beyond cursory explanation is necessary? Surely some degree of analysis is valuable for dissecting client motivation, if only for understanding expectations and designing an appropriate charitable strategy. But is there such a thing as too much digging into the psychological terrain in the cause of dispensing prudent philanthropic advice? And even if definitive and complete explanations of altruism are possible, could a client articulate the catalysts? Or even recognize the answers within?

No one asks such questions in conventional finance since the answers are easier to come by. Knowing that Ms. Smith is investing for her year-old son's college education as opposed to retirement in five years is a critical distinction for crafting portfolio strategy. Fortunately, such information is available for the asking, and the motivation is self evident. Is a comparable level of analysis about intent and expectations equally vital in search of the true charitable impulse?

"It's important to understand what motivates a client," says Bruce Boyd, principal and managing director in the Chicago office of Arabella Philanthropic Advisors. "Whether they're motivated by true altruism or some less-altruistic purpose, many of the steps one has to take to institute a sound philanthropy program are the same," he explains. "If someone's interested, as some donors are, in being recognized in their community as philanthropists, that's fine and it's perfectly appropriate. We'd run more or less the same process with them as the donor who wants to be anonymous."

Maybe so, but it's premature to assume universal truths or turn-key solutions. Yes, the plumbing behind charitable giving--donor-advised funds, foundations, etc.--is widely known and used. But satisfying the wealthy sometimes, perhaps most of the time, requires more than simply selecting products and directing donations. Sometimes the journey is as important as the destination. In fact, the former has been known to determine the latter.

Eric Kramer tells of one wealthy client's evolution in thinking about philanthropy. It began with the sale of the family company a decade ago, producing a nine-figure portfolio and, in time, earnings that were directed to philanthropic causes, says Kramer, principal and chair of the investment committee at Crestone Capital Advisors in Boulder, Colo. The family spends about a third of the year in Africa, building water projects, schools and hospitals, he says. It's a particular brand of philanthropy, and one that appeals to the client. Yet the strategy developed over time, transitioning into what's effectively become a customized philanthropy program for one family.

"They were a traditional charitable family until they sold their company in 1998," Kramer relates. "They were givers but not philanthropists." That changed after a wave of cash washed ashore. "They said, 'We really want to use the money for the betterment of society.'" Then they focused on figuring out what that meant for the family. "They found that giving to other organizations, foundations and causes was unfulfilling because they didn't feel a connection [with the giving], and they weren't confident that the money was going where they wanted it to go." But this was no overnight change of strategy. "They did some systematic experimentation and found out what worked well for them and what didn't."

Engaging in philanthropy was always the family's goal, but not just any charitable strategy would do. "I think you really have to understand the personality of the client, maybe the experiences or the needs that are driving [the charitable intentions]," Kramer advises. "Otherwise, you go into the toolbox, and start throwing all this stuff on the table, but that doesn't really help them address what they're trying to accomplish."

If understanding why people give is as relevant as the decision to give, one might wonder what economists can tell us about the distinction. Modeling altruism is a fairly recent development in the dismal science. For a benchmark, we can start with what's known as the theory of perfect altruism. Under this assumption, people who make charitable contributions are focused on the total donations that a charity receives. As such, donations are viewed as a zero-sum game, and so the "crowding-out" effect applies. Increased giving by one donor will be offset with a decrease by another. If the government increases funding for a worthy cause, the increase will trigger a reduction in private funding or vice versa.

In the 1980s, researchers began challenging the idea of crowding out. Economist James Andreoni, for example, proposed a model of impure altruism, which develops the notion of "warm glow" giving. That is, donors enjoy giving for the sheer satisfaction that comes from helping others, at least partly. Recent studies lend support for the warm glow theory. For example, real (inflation-adjusted) growth in private charitable giving in the U.S. grew by 2% annually in the 40 years through 2005. The pace is matched by the rise in federal, state and local government spending over those four decades, according to a 2007 study published by the St. Louis Federal Reserve (see the Crowd Behavior graph). "Over time, a growing component of government spending has been for health, education and social services, the same services to which some of the largest shares of private contributions have been made," the report explains.

Another model proposes status as a motive. Applying econometrics to an idea first discussed in the 1800s, a 1996 paper in the American Economic Review presents evidence that "the desire to demonstrate wealth, perhaps because individuals prefer to socialize with individuals of the same or higher social status" offers one explanation of the altruism drive.

Economist William Harbaugh labeled the pursuit of status as the "prestige benefit." In a 1998 study in the American Economic Review he analyzed the data records of gifts by lawyers to their alma mater and found that a fondness for prestige accounts for a substantial portion of donations.

Crestone's Kramer says the prestige factor is easy to spot. "You can definitely identify the people who are looking to enhance their standing in the community or in the world. They want their name on a foundation," he says.

Others go to the other extreme and prefer anonymity. "If you go to the local hospital and look at the plaque on the wall, there will almost invariably be a listing for 'anonymous' with four or five donors who've given, but don't want their names used," says Arabella's Bruce Boyd.

"You can sort of see the emotional needs that are driving the decision," explains Kramer. Recognizing those signs helps "guide them to the solutions that meet their emotional needs."

The first step is identifying what those needs are. Don't assume the client knows. "Our job is to help them identify the way in which they can most effectively engage," explains Boyd. "It depends on the sophistication of the client."

Boyd adds that each client comes to a state of charitable epiphany in his or her own way. It may arise out of frustration that a familiar piece of pristine property is giving way to urban development, which in turn sparks a desire to join the conservation cause. Or maybe a family member or friend was stricken with a disease, which inspires new efforts to help find a cure.

The influence of the personal in philanthropy was on public display recently, when Sergey Brin, a Google co-founder, wrote on his blog that he had a gene mutation that increased his risk of developing Parkinson's disease. "This leaves me in a rather unique position," he explained to the world. "I know early in my life something I am substantially predisposed to. I now have the opportunity to adjust my life to reduce those odds (e.g. there is evidence that exercise may be protective against Parkinson's). I also have the opportunity to perform and support research into this disease long before it may affect me."

Yet it's the rare client who arrives with a detailed strategy that's set for action. Ready or not, the well-heeled set tends to be philanthropically inclined, even if members of this elite club are not sure how to turn their enthusiasm, anger or fear into a charitable reality.

"Many high-net-worth clients of wealth managers care as much about philanthropy as they care about their investments and financial resources," says Arabella's Boyd. "Philanthropy is often an avenue for them to express their interest or passion for a particular cause."

Perhaps that's why A. P. Giannini, Bank of America's founder, famously observed: "No man actually owns a fortune; it owns him." Why? Ask any billionaire, or his wealth manager.

James Picerno (jpicerno@sbmedia.com) is senior writer at Wealth Manager.

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