A smarter way to pick your charity

When you're choosing a cause to support, act as if you're making an investment - because you are.

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By Jean Chatzky, Money Magazine editor at large

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Editor-at-large Jean Chatzky appears regularly on NBC's Today. You can contact her at money_life@moneymail.com.

NEW YORK (Money Magazine) -- Like most donors, you probably spread your charitable contributions among several groups that you know or that your friends ask you to support. But when the request for help goes beyond the routine $50 or $100 check or if you decide on your own that you'd like to do something a little more significant, how do you know your money is going to the right cause?

If you're a savvy giver, you look up how much of a charity's income goes to programs, as opposed to overhead, by consulting Web sites like Charitynavigator.org or by looking over the IRS form 990 that the charity files (available at guidestar.org or on the charity's site). The higher the so-called program ratio, you figure, the better job a charity does deploying your money.

Indeed, that's the approach I've always taken, and I have often advised TV and radio audiences to do the same. So I found myself stunned recently when I attended a seminar on giving and I heard Katherina Rosqueta, a former McKinsey consultant who now heads the Center for High Impact Philanthropy, say that the so-called program ratio is the wrong way to evaluate a nonprofit. If you can't use it, what's the alternative?

There are two big problems with the ratio, Rosqueta explains to me later. The first, she says, is that the ratio doesn't get at how effective a program is. A food bank may shell out a lot on its program, but how many people is it feeding? "When you're talking about the program ratio," Rosqueta says, "you're focusing on what you're spending, not what you're creating."

The second problem, she says, is that the ratios are easy to manufacture. A charity, for instance, could allocate some piece of its executive director's salary to its program budget instead of to overhead.

The right comparisons

Slice and dice. Mutual fund investors, particularly those schooled by Morningstar and its "style boxes," know that you don't compare apples and oranges. You compare funds that invest in growth stocks with other funds that do the same, or value with value and small-cap with small-cap. Do the same with the program ratio.

"Compare organizations that have similar missions," explains Trent Stamp, president of Charity Navigator. "The worst food bank spends 90 of every dollar on its programs because, basically, there are no administrative costs.

Yet it's rare to find a museum that spends more than 75 on the dollar because museums need guards, insurance and big buildings. So you look at how my food bank compares with your food bank. Not how my food bank compares with your museum."

Charity Navigator recently introduced a widget on its Web site that lets you make comparisons, or you can download 990s and make them on your own. As benchmarks, Stamp says, colleges and universities should have ratios "well north" of 80%, health-related charities should be around 80% and social service groups at 75%.

Charities less than two or three years old shouldn't be evaluated on the basis of program ratios because their start-up costs by definition are overhead.

Consider other data hiding in plain sight. One reason givers rely on the program ratio is that it's easily available. But there are other data points on the 990 that are just as important. Revenue growth combined with growth in spending on programs from year to year signals a financially healthy organization, for example.

That's good: Fiscally sound groups are more likely to be effective. "Struggling charities can't hire and retain good people," says Stamp. "They can't lock in contracts."

Dollar-in, dollar-out used to be a not-for-profit adage. No longer. Most nonprofit CEOs want a rainy-day fund so that in the event of an economic downturn they can keep their people and still plan for the future. Stamp suggests that you look for charities that have at least six months' working capital saved, meaning they could fund their operations for that amount of time with what they have in the bank.

Finally, there's the issue of CEO pay. Charities have to disclose CEOs' compensation, as well as that of other highly paid employees. (It's on the 990.) Again, compare groups that have similar missions and staff sizes. "And if a salary seems out of line," says Stamp, "it usually is."

Get past the sales pitch. Fund raisers will often tell you how important your donation is and spend a fair amount of time buttering you up. Their job, after all, is to get you to open your wallet. Yours is to make sure that your dollars are doing the most good. You want answers to questions like "What are this group's goals for the year?" and "How will it reach them?" and "What's the measure of progress?"

Well-run organizations welcome those questions. Some, says Rosqueta, may have compiled "impact assessment" reports at the request of large potential donors in the past and may be willing to share them with you. If not, ask for annual reports or copies of client or volunteer evaluations.

You're searching, she explains, for anything that gets at cost effectiveness. If a program is aimed at reducing an area's high school dropout rate, has it worked? And how much did it cost to achieve that reduction? "Now you're looking at the things a rational philanthropist would look at," she says.

The impulse to give comes from the heart. But the actual giving? As you would with any investment, use your head.

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Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.