10 December 2015
In praise of benevolent billionaires
by Frank O’Nomics
News that Mark Zuckerberg is giving 99% of his fortune to set up a charity to support “personalized learning, curing disease, connecting people and building strong communities” has prompted widespread praise, perhaps most succinctly put by Michael Bloomberg who said that this “sets a new giving standard”. However, it has also provoked some cynical responses from those think this is a tax dodge, a PR stunt, or both. It is of course worth spending some time to think about how generous this “donation” really is, and how it compares with other philanthropic gestures from very wealthy people. I will come to this; but for me the announcement was perhaps most interesting for prompting the reconsideration of two investment maxims drilled into me in my early days in the City.
The first is the warning never to spend your capital; only spend income. Once you start spending capital you erode any financial safety that you have built up and it is hard to get that back. There is a natural instinct to want to provide for dependents, and to spend capital is to erode their inheritance. The second is the argument that true wealth is being able to live on the income provided by your income, ie to ensure that you sustain the compound growth of your wealth you reinvest the income; you then live off the income which that income generates. Mr Zuckerberg seems to be in danger of breaching both maxims, which to me highlights the extent of his generosity.
That the Zuckerberg’s are significantly reducing their net wealth, ie spending their capital, requires no explanation, but the second maxim should perhaps be explained more fully. If you need $10,000 of income to be comfortable (I wish!), and savings rates are at 5% (more wishful thinking) then you would need a capital sum of $4 million to be regarded as truly wealthy, as $10,000 is 5% of 5% of $4 million. Clearly this maxim was devised at a time when interest rates were much higher, but if we were to assume that Mr Zuckerberg needs $10 million of income to keep him happy, and that long-term rates are currently around 3% (the yield on a 30 year US Treasury bond), then on this view he would need a capital pot of $11 billion. Well if, on current valuations, the Zuckerberg’s facebook share holding is worth $45bn then they are taking something of a risk by leaving themselves with less than $1bn (closer to $2bn when other aspects of their wealth are included). The transfer of the Facebook shares will take place over a number of years (at up to $1bn of Facebook shares per year it will take a long time) and this would seem to give the Zuckerbergs some interim protection, and clearly it remains to be seen what price the shares are able to command over this period. Nevertheless, the Zuckerberg’s, like the Gates’ before them, do seem to have given an answer to the question regarding wealth – just how much is enough?
But what of the gesture itself? There has been some criticism of the fact that the Zuckerberg’s have not set up a charitable foundation, which would require 5% of the endowment being spent on charitable causes each year. Instead they have created a limited liability company which can invest in companies, lobby for legislation and engage in other activities that non-profit entities are not allowed to do due to tax law. There is no need to disclose the financial affairs of the new LLC and they could disburse a profit if they chose to. Mr Zuckerberg has said that any net profits “would be used to advance this mission” and it would seem very unfair to question this. There is also some suggestion (in the New York Times) that they have made this move in part to reduce their tax liability and for the very positive PR it has given them. That too seems somewhat churlish and Mr Zuckerberg has argued that they receive no tax benefit from the move (which they would have done if they donated to a traditional non-profit organization) but do “gain flexibility to execute our mission more effectively”, and that they would pay capital gains tax on any shares held.
It is interesting to compare the Zuckerberg’s generosity with that of the world’s wealthiest couple, Bill and Melinda Gates. They have pledged to give 95% of their wealth, currently around $85.2bn. This would clearly give them a more substantial pot of $4.25bn to live on (to continue the logic above, $3.8mn is the interest on the interest at 3%). However, the Bill and Melinda Gates Foundation is a non-operating private foundation (with a global ambition to enhance healthcare and reduce extreme poverty) and has to pay out 5% of its assets each year. Warren Buffett (net worth around $66.7bn) has pledged most of his fortune to the Gates Foundation. Buffett, together with Bill Gates, set up the Giving Pledge in 2010. This encourages the world’s wealthy to give more than half of their fortune, either through their lifetime or in their will, to philanthropic causes. As of the middle of this year 193 individuals had signed up to it (you can see the list on www.givingpledge.org). The pledge does not involve a pooling of money or the supporting of a particular set of organizations, merely asking for a commitment to philanthropic causes or charitable organizations.
The Zuckerbergs are signatories to the pledge and have amply demonstrated their commitment by the setting up of their new organization, the Chan Zuckerberg Initiative. To question the nature of their commitment because they utilize a LLC rather than a non-profit organization would seem to be very unfair. These are two people in their early thirties, making a lifelong commitment to philanthropic causes which would seem, on historic investment maxims, to be somewhat brave. Criticising their decision to devote such a huge proportion of their wealth runs the danger of discouraging others from doing the same. A billion $ here and a billion $ there and pretty soon you are talking about real money. Just think what good that could do.
