It’s important for investors to understand how charitable donations and taxes will impact their bottom line

When you complete your income tax return, take a moment to consider the charitable donations you made. How carefully did you choose the charities you supported? How much time did you spend to investigate how they’ll spend your money? How do you feel about charitable donations and taxes?

Many people find it uncomfortable to inquire into the goodwill or efficiency of any charity. However, there are limited funds available in the world for charitable purposes. The cause or people you want to help are in no position to demand an accounting or take their business elsewhere. The more that goes to waste, the less there’ll be for those you want to help. But the quality of charities varies as widely as the quality of stocks you can buy for your portfolio.

Charitable donations and taxes: Don’t fall for intriguing concepts

Unfortunately, all too many charitable donors pick charities the way beginning investors pick stocks. They get seduced by an appealing concept. They make snap judgments in response to a photo or sound bite, or the recommendation of a friend or acquaintance. A little digging can go a long way toward making your donations work harder and bringing you closer to the goals you had in the first place.

Charitable donations and taxes: Know where your money is going before you donate

One key factor to consider is how much of the charity’s revenue goes to charitable purposes (as opposed to administration and fundraising). I like to see charitable spending make up a minimum 80% of the total. Lots of charities devote little more than half their budget to charitable purposes. At some surprisingly large and seemingly reputable charities, administration and fundraising expenses eat up 40% or more of donations.

You’ll also want to discount contributions to other charities (which are referred to as “qualified donees,” since they are also qualified to issue charitable receipts). If you donate money to a charity that spends half its budget on administration and fundraising, and it in turn donates to another charity with a similar budgetary arrangement, then only a quarter of the original donation goes to its intended purpose.

Note that even highly regarded charities sometimes fudge the numbers. For instance, they may attribute some of their telemarketing or fundraising ads to, say, “public education.”

The charity business, like the stock-promotion business, has great appeal to unscrupulous operators. That’s because both industries deal in intangibles. In fact, the same crooks have been known to move from one area to the other, and back again.

In charities, as in investments, there are no limits to the ways in which a dishonest operator can cheat. If you have any doubts about the integrity of the insiders at a charity or behind an investment, it’s best to look elsewhere.

Examine a charity’s “business plan” before donating

Bad stocks devote much of their effort to promoting their stock prices, and overplay progress they make in their businesses. Similarly, bad charities devote the bulk of their budgets to fundraising and administration costs, while touting the limited charitable work they do.

The first thing to look at when evaluating charitable-donation tax shelters is the proportion of a charity’s budget that goes to fundraising and administration.

You also need to look at what you might call the charity’s “business plan.” Does it make sense? Is the charity equipped to pursue its objective in an effective, efficient manner? If not, other charitable organizations may be able to put your donation to better use.

You can get free annual reports from charities, just as you can from public companies. In addition, the Canada Revenue Agency compiles information about charities in a free database.

Bonus tip: Wealth building strategies involve selling if you doubt the integrity of insiders

It’s always a good safe investing strategy to sell your shares in a company if you have any doubts about the integrity of the people in charge. In other words, if you think a company is run by crooks, you should sell right away, no matter how attractive it seems as an investment. There are no limits to the ways in which unscrupulous operators can and will cheat you.

To profit from this safe investing rule—that is, to use it to enhance your long-term returns, not just avoid losses—you need to apply it in a moderate fashion. You need to distinguish between lack of integrity on the one hand, and naiveté or poor judgment on the other.

How careful and knowledgeable are you with charitable donations and taxes? Have you ever invested in a charitable cause that ended up being a scam?

In your opinion, what are the worst charity scams you wish people knew about?