Does generously giving 10% of after tax income actually outperform the S&P 500?
As someone focused on building long term wealth through prudent financial planning and investing, why in the world would I routinely give a percentage of these earnings away? It seems completely counterproductive to strive to build wealth and at the same time be generous.
I can understand first building vast amounts of wealth, and in the comfort of millions deciding that philanthropy is a worthy goal. But giving wealth when we are of modest means seems a bit foolhardy.
In studying wealth creation I have repeatedly encountered the purported wealth building benefits of giving 10% of one’s after tax income to charity - often as a tithe to one’s religious establishment. This eyebrow raising idea has led me to examine a somewhat far-fetched proposition - that giving 10% of one’s income to charity will actually outperform market returns, resulting in larger wealth generation than if that same 10% were invested in a market index. I will explore this seemingly paradoxical suggestion and suggest some of the mechanisms that may facilitate its validity below.
My relationship with giving
I have never been an especially generous person when it comes to what is actually precious to me. While I have given to charity on a monthly basis, the level of my giving has not been anywhere near the Biblical charge of tithing. My generosity has more often than not been giving when it is convenient - I am moving and I’m generous with my old furniture (I just need you to come pick my old sofa with a truck), or I am getting a new phone and I’m all of the sudden generous with my old electronics. While this generosity of convenience is no doubt helpful and appreciated, it is quite different from the true generosity of gifting a precious resource - which for almost everyone is money.
Money is the hardest thing to give
I can give endless rationalizations as to why money should only be given sparingly. No doubt we’ve all practiced many justifications to avoid the discomfort of regularly integrating generosity into our monthly budgets. There are several reasons I’ve found that generosity with finances should be done extremely judiciously. These are the principles that have helped me avoid generosity the most throughout my years - while I still believe these principles to some degree, I working to discard them in favor of being more generous.
Questionable justifications to avoid generosity
It is much harder to make a philanthropic profit than make a capitalistic profit. - Financial generosity will generally go to waste. It will not be used efficiently to actually improve anything by some well-intentioned but ultimately ineffective charity or non-profit. Better that I deploy my own resources for my own benefit, than entrust said resources with others who will not care as much.
Giving 10% of income to religious charitable causes is anachronistic. Today, we have social safety net programs through taxation. - By attending a church regularly, I should only give a reasonable amount to reflect the amount of resources my membership consumes in the church organization - similar to a country club membership. A church serves an admirable role in the community which I’m happy to be a part of, but 10% of my income is simply too much and not applicable in the modern sense given that I also pay income tax, property tax, sales tax, etc., which support the common good and provide social safety nets. I may not agree with this taxation system, but I have no choice but to participate.
Being overly generous with financial resources simply enables the dependents of society to operate free from the constraints of financial realities. - If I routinely support others financially, they will likely become reliant on my gifts which will inhibit their own development and competence. I exist in a world of financial realities. These economic realities have helped me grow, The organizations around me should be forged in the same fires.
I am still convinced of the validity of these three generalizations, but I’ve recently opted to forgo them in the interest of searching for broader reasons and benefits that generosity can offer. The fact is that giving is a financially irrational act when examining it from a surface level.
In a world of market efficiency where it is theoretically impossible (or perhaps extremely unlikely) to sustainably beat the market, how could giving ever be anything more than simply a kind thing to do?
Does generosity actually increase your wealth?
It seems absurd that to even suggest that by giving money away, you actually will increase your rate of wealth generation. However, sources of wisdom both ancient and modern suggest exactly that. Biblically, we see the prescription of a “tithe” - or giving away 10% of one’s income. In the contemporary context, we see financial gurus such as Millionaire Next Door author Thomas J. Stanley elucidate that generosity (most commonly tithing to a church) is a recurring theme amongst “everyday millionaires”. Radio talk show personality Dave Ramsey teaches that giving is a critical part to wealth building regardless of one’s situation with debt.
It is easy to assume that generosity is correlated with high net worth individuals simply because people who generally make a bunch of money are then comfortable giving. This does not seem to be the case though - giving appears to be a critical element of actually generating wealth.
Put into an investment context, generously giving away 10% of our after tax income actually has a higher rate of return than allocating that same 10% to a market index like the S+P 500. Despite an immediate financial penalty of 10% (or more grimly, an immediate 100% loss), we see evidence that suggests that giving is the better use of funds, even if your goal is good old fashioned greedy wealth maximization. This seemingly paradoxical proposition would be readily dismissable, except we see it repeatedly enough amongst a diverse array of sources that it warrants further examination.
What could the actual mechanism be that would cause giving to outperform the S+P 500?
I’ve recently sought out to explore this question. While I’m still far from convinced that giving a reasonable amount of one’s after tax income (usually 10%) outperforms the S+P 500, I have come across several compelling arguments. I will outline a few of these potential mechanisms below.
Mechanism Idea 1: Giving is a cost effective way to frugally achieve satisfaction and fulfillment.
In Thomas J. Stanley’s book Stop Acting Rich, we learn in a data driven yet common sense manner that frugality, not income, is most correlated with wealth creation. In a similar vein, he explains the paradox of how giving is conducive to wealth creation in that giving is actually a cost effective way to achieve life satisfaction and fulfillment, which facilitates increased frugality.
How is it possible that the group which donated significantly more money was able to accumulate more wealth? People allocate their dollars in ways they feel will give them the greatest satisfaction. I believe that these people feel that giving is a substitute for spending more on products and pleasure-related services. They seem to get more satisfaction from accumulating wealth and giving than from consuming more.
Stanley, Thomas J.. Stop Acting Rich (p. 232). Wiley. Kindle Edition.
Basically, we all have a need to feel satisfaction - that our money, our lives, and our work is meaningful. We need to feel a sense of achievement, and that our work warrants the respect of others. Oftentimes, this need for esteem and belonging can result in purchasing hedonic luxuries that are balance sheet killers. Examples of these expensive searches for fulfillment can include expensive homes in high end neighborhoods, money pit boats, rapidly depreciating cars, or keep-up-with-the-Joneses inducing country club memberships. While these items can occasionally be purchased responsibly by individuals with sufficient net worth, more commonly, these luxury purchases are a hallmark of bad financial decision making.
Perhaps an even greater cash flow crippler can be found in the bad habits and dubious personal decisions that result from life dissatisfaction. These include examples such as developing costly gambling habits, buying into get rich quick schemes, or going after a trophy wife that may ruin one’s finances with the ensuing divorce(s).
Stanley is arguing that diverting 10% of our income to generous giving endeavors is actually a very cost efficient way to achieve life satisfaction which will drastically reduce our likelihood of making devastating financial mistakes. If we were robots, the 10% would be better allocated in the S+P 500, but since we are wondrous humans with Maslovian needs, we should plan to take advantage of that shiny new deal of buying life satisfaction via generosity, which can be ours for the tidy sum of just 10% of our income.
Mechanism Idea 2: Giving generously increases your sense of self-worth, making you a more desirable person to transact with in the business realm.
Another potential mechanism is that giving improves your sense of self esteem. This higher level self image is felt in a genuine, deep, and sustainable way which is apparent to others. Given that wealth is generally built through transactions, this in turn means that you are a more desirable person to do business with.
In his book Thou Shall Prosper, Rabbi Daniel Lapin elaborates on how our perceptions of others can affect how willing we are to transact. One of the key perceptions that we can all identify with is when someone asking us to transact exudes an excessive sense of desperation. We perceive this desperation and it alerts us that we need to be extra careful and guarded. A desperate person who is overly eager to buy or sell with us requires an additional level of verification and trust.
Think of the tired and disheveled salesman who is a bit too eager in their approach. The TV show The Simpsons has a recurring character who embodies this business pitfall well in “Ol’ Gil” - an unlucky salesman who just can’t seem to catch a break. Now obviously Gil is a fictional character, but would you guess that Gil tithes to a local church, or gives generously to charitable causes? Almost certainly not - magnanimous giving is synonymous with success and wealth creation.
According to Rabbi Lapin, The Midrash on the Book of Proverbs proclaims “if you see someone donating to charity, be assured that his wealth is increasing.”
Giving a reasonable amount of our income to worthy causes naturally improves our self-image in a way that allows us to shed desperation and self-doubt and present ourselves in a more confident and capable light. This in turn makes us more attractive and desirable in the financial marketplace. We are more likely to make decisions that are in line with a wealthy person as our internal sense of consistency becomes rooted in a belief that we are financially competent and successful. We become larger, more generous, and more magnanimous - people want to join us on the path to wealth creation.
This psychological mechanism is an abstract yet legitimate reason that giving 10% of our income to charitable causes may outperform the S+P 500 in that we are achieving significant personal and professional improvement for a relatively modest cost.
Mechanism Idea 3: Giving gives us routine practice with risk taking, setting us up to be better prepared to capitalize on opportunities.
A third potential mechanism which could cause giving to outperform market returns has to do with risk. Routinely giving to charity familiarizes us with investment and risk taking. Understanding that 10% of our incomes will be given away each month from our own volition familiarizes us with trusting our decision making abilities and risk assessment. We hone our ability to trust what is beyond our control and expect that the results will be beneficial - as they usually are.
However, the key to this mechanism lies in our ability to better shoulder the burden of risk in the pursuit of greater benefit. While a certain prudence is expected to verify that the recipients of our charity are legitimately mission oriented, we must be okay with the fact that once the money has left our possession and the results are beyond our control. Generousity is and inehrent risk. We develop a sense of equanimity with our money - we no longer need to win all the time - risk is becomes acceptable.
As Rappi Lapin puts it in Thou Shall Prosper, “You see, some people simply cannot invest in anything. They are afraid of losing their money. They cannot comfortably invest in stocks, bonds, or any other security and neither can they invest in their own business. Invariably, these people are equally incapable of charitable giving.”
Giving familiarizes us with the core act of investing. We begin to voluntarily take on risk in a new light, and we maintain our sense of dignity, calmness, and composure in the face of uncertain results beyond our control. This investment aptitude then sets us up to recognize and capitalize on wealth building opportunities that arise in our business lives. If we have a track record of our money following our convictions, as giving trains us to develop, we are more likely to capitalize on these wealth building opportunities in the for profit, capitalistic arena.
Giving is almost certainly a cause of wealth creation
While it is easy for us to assume the inverse is true - that wealth creation is a cause of giving, we see time and again that generosity is a reliable precursor of financial success. While the specific mechanisms may vary, the track record and testimonials are just too indicative of a broader trend. For an individual focused on wealth creation, it is likely true that generously giving 10% of one’s income to charitable causes will outperform the results of simply allocating that same 10% to the S+P 500. Put a different way - generously giving 10% of one’s income to charity could be a fantastic portfolio diversifier that offers better risk adjusted returns.