Behavioral Finance of Impact Investing

Undeployed charitable assets in donor-advised funds (DAFs) reached $121.4 billion in 2018—including $33.9 billion at Community Foundations. Most of these undeployed funds are invested in conventional financial instruments. However, DAFs present a unique opportunity to promote impact investing into the local community, including Community Development Financial Institutions (CDFIs) that serve their local communities. In addition to having already expressed a clear interest in using funds for social purposes, DAF donors could potentially realize a double-bottom-line benefit by placing undeployed funds in impact investments rather than traditional stocks or bonds. Community impact investing should be an appealing option for DAF donors at Community Foundations. The donor has already relinquished any possibility of personal benefit from the funds in their DAF, and should therefore be interested exclusively in maximizing the social impact they can generate with their funds. Lending the money to a social interest project or organization for a few years while the donor decides where to grant the funds seems like a rational strategy to achieve greater impact. A substantial body of evidence from the field of behavioral economics suggests that most people do not, however, make rational decisions about their investments or finances. Instead, a variety of cognitive biases tend to drive their decisions, often resulting in sub-optimal financial outcomes.

In this study, DAF donors were invited to complete a survey by the local community foundation that held their investment. In the survey, the donors were asked to imagine that they had just contributed a sum of money to their donor-advised fund. The survey then asked the donors to determine how they wanted to invest their funds before they were granted out to charitable organizations. Donors were given four options, allocating between them a percentage of their funds. Donors could then select the desired term and interest rate for their investment in the local community impact fund. The results suggest that Community Foundations can exert considerable influence over donor allocations to community impact investing funds simply by changing how they frame the request. In particular, if Foundations are willing to recommend a default allocation to community impact investments—even while allowing the donor full choice over the final allocation that is actually implemented—they will see
substantially more funds going to this use.