Aren’t the best charities those with the lowest overhead costs?

11 min read
31 Jan 2023

I used to be heavily sceptical about charitable giving. I wanted to help others, but worried that my charitable donations might be doing little more than alleviating my own guilt. After all, how could I know that my money was actually doing something? The pile of address labels, stickers, and greeting cards arriving in the mail from charities I didn’t even donate to certainly didn’t inspire confidence; why were charities spending precious funds on unsolicited address labels while simultaneously putting out “urgent funding appeals” left and right?

Because I wasn’t sure how to evaluate the impact of a charity’s programs, I instead would focus on a charity’s spending habits: in other words, I would use Charity Navigator or a similar website to look up the percentage of funds spent directly on the charity’s programs vs. on administrative costs/CEO pay. I told myself that the charities spending the most on their programs must be better than those spending more on overhead.

I was certainly not alone in my method for choosing charities. Many donors use this ratio (emphasised by several charity evaluation websites) to determine where to give. And it makes sense on a surface level, especially since it’s fairly common to lump charities into one general “doing good“ bucket, without stopping to consider the differences between them. If you believe all charitable programs are doing roughly equal amounts of good, then those that funnel more money to their “doing good” programs surely must be better than those that funnel less money to those same programs.

Right? Wrong. While I’m still sceptical of what I’ll term “the address label brand” of charity outreach, I no longer believe that the ratio of a charity’s administrative costs to program costs is a good way to determine whether my donations will make a difference. This article will explain why.

That said, before getting into the nitty-gritty, I want to be clear on one important point: shaking what is often called “the overhead myth” doesn’t mean I’ve lost the impulse to question where my donation is going. In fact, now that I know there’s more to evaluating a charity than examining its spending habits, I’ve actually become far pickier about where I donate. As a result, I’m more confident that the causes and charities I choose to support are truly making a difference.

What is the overhead myth and why does it matter?

In brief, “the overhead myth” is the mistaken (but widely held) belief that charities with lower overhead costs are more effective.

It matters because most of us donate to help people, society, or the world in some way. Finding a more accurate way to determine which charities best help us achieve those goals is certainly useful.

So if you — or people you know — have been using the overhead vs. programs ratio as a measure of a charity’s efficacy, here are a few reasons to reconsider that approach.

Why aren’t overhead costs a good measure of a charity’s impact?

First and foremost, “overhead costs” don’t tell us anything about the outcome of a charity’s programs. To determine whether our donations will be impactful, we need to know what will happen as a result of donating, and then choose the option that helps the beneficiaries the most. While overhead costs should certainly be kept reasonable, there are several issues with relying on the overhead ratio to determine a charity’s impact:

Overhead costs don’t consider differences in program efficacy

Not all charitable programs are equally effective. Perhaps the most obvious issue with choosing charities based on their overhead costs is that we’re neglecting to factor in what these charities are actually doing, and whether it’s impactful.

Will MacAskill, a co-founder of Giving What We Can, offers a silly (but eye-opening example) in Chapter 7 of his book Doing Good Better. He asks the reader to imagine that he has created “a charity that distributes doughnuts to hungry policy officers.” In MacAskill’s example, the majority of donor funds are spent directly on the program itself — buying and distributing doughnuts — and only 0.1 percent is spent on overhead. He then asks the reader, “Would I really have created an amazing charity? Surely…what we should ultimately care about is the impact charities have. When you give a hundred dollars to a charity…how are people’s lives improved as a result?” (MacAskill 108).

You may think that it’s fairly obvious whether or not a charity’s programs are worthwhile, and that you’d be able to tell just by reading a bit about what the charity does. After all, after hearing the description of MacAskill’s doughnut charity, you’d likely know there were better places to funnel your hard-earned resources!

But program efficacy isn’t always so simple, or intuitive. There are countless examples of charities that sound amazing on paper but end up doing little to improve the lives of others — or even, in some cases, causing outright harm. That’s why it’s important to closely examine the evidence behind the programs a charity is running, rather than just relying on the program’s description or marketing. Stark differences in program efficacy and other factors simply aren’t captured by looking at overhead spending, and can end up making one charity tens or even hundred of times better than another.

It may not be logical to separate “overhead” from “program costs,” since this distinction isn’t clear cut

We’re used to thinking about overhead and program costs as two very distinct spending buckets. But if we really stop to examine what overhead is, this separation begins to break down. In fact, without overhead spending, there wouldn’t be any program spending at all! Why? Because “overhead” is merely the people, resources, and tools needed to run an organisation. To run its programs effectively, an organisation needs to hire talented people to keep it afloat (overhead!)  and fundraise to drive money to its programs (also overhead!) If an organisation doesn’t run effectively, it won’t be able to run its programs well. So why the insistence that charities should spend as little on overhead as possible?

Part of this may have to do with a misconception that the business rule of “spending money to make money” doesn’t apply in the nonprofit sector. Dan Palotta attempted to remedy this misconception in a 2013 TED talk, and soon after, some well-known charity evaluators apparently attempted to correct their embrace and promotion of the overhead myth. However, despite some moves within these organisations to focus more on impact, it seems like this change has yet to take hold. Charity Navigator, for example, still uses percentages of program, administration, and fundraising spending as part of a charity’s “financial health” rating. The organisation acknowledges that “effective charities must recruit, develop, and retain talented people,” but they also state that “Givers support charities for their programs and services, not for their ability to raise money.”

While this is certainly true, it’s kind of like saying that farmers are useful for their ability to provide food to people, not for their ability to grow crops. Since their ability to grow crops directly affects their ability to provide food, this statement isn’t entirely logical. Unless a charity was only fundraising to cover the cost of fundraising staff (equivalent in our metaphor to a farmer only growing crops with no plans for distribution), donors and charity evaluators should acknowledge that more money raised often means more money funnelled to a charity’s programs/services!

Much has been written about the dangers of charities skimping on overhead to meet donor expectations. We already touched on the well-known TED talk by Dan Palotta, which goes into detail about some of these dangers. Jonathan Meer, in a 2017 paper, writes that too much donor focus on overhead “can lead charities to underinvest in crucial operating infrastructure, especially skilled workers, thereby diminishing their ability to deliver services.” This topic is also explored in an article entitled “The Nonprofit Starvation cycle,” in which the authors open with the statement: “Organisations that build robust infrastructure—which includes sturdy information technology systems, financial systems, skills training, fundraising processes, and other essential overhead—are more likely to succeed than those that do not. This is not news, and nonprofits are no exception to the rule.” In fact, it turns out some nonprofit organisations even engage in misleading reporting/significant underreporting of their overhead costs, likely because of stringent (and misguided) donor expectations.

What if overhead was a good measure of a charity’s efficacy?

Even if examining the ratio of overhead to program spending did help us make informed decisions about choosing charities (and I hope you agree by now that it doesn’t), this metric does very little to narrow down our giving options. The result of so many charities striving to meet overhead expectations (whether through underspending, misleading reporting, or both) is that an overwhelming number of organisations — differing widely in their efficacy — trumpet low administrative costs. Over 250 charities are listed by the website Charity Watch as “top-rated,” a categorization that necessitates (among other criteria) spending at least 75% of their budget on programs. Thus, even if we assumed that low overhead was a good way of determining where to donate, we would still need a framework for deciding between all the charities meeting this criteria.

Interestingly, the website CharityWatch acknowledges this, stating on their “Top-Rated Charities” page, “Because many factors determine a worthy charity, we at CharityWatch suggest that you use the ratings on this page not as the sole determining factor in your decision, but rather as an aid.” Unfortunately, the page does not mention what these other factors might be, nor provide information about the (arguably) most important factor for determining the efficacy of a charity — the impact of the charity’s programs.

So it’s clear that we need a better framework for determining where to give.

Cost-effectiveness: everything you thought overhead was and more

If you’re still clinging tight to the idea that overhead spending must tell us something about the efficacy of a charity, you’re not alone. Organisations certainly shouldn’t spend so much keeping themselves afloat that relatively little is left for what they actually claim to be doing, because then our modest donation might not help those in need. In other words, most of us are attracted to the overhead myth because of the intuition that we should make sure our money is really supporting the cause in a tangible way.

This intuition is absolutely correct; it’s just that examining overhead spending isn’t the way to approach it. We’ve explored how money donated to charities with low overhead costs can actually do very little to support a particular cause —  especially if the programs are ineffective —  and how charities with higher overhead costs can actually do quite a lot to support a particular cause, especially when those costs end up funnelling more funds to high-impact programs. So, rather than looking at overhead to determine where our money will go farthest, we can use a more accurate measure: cost-effectiveness.

If Charity A and Charity B are equally impactful, and Charity A spends less overall, then Charity A would be more cost-effective. In other words, if I can have the same impact by spending less money, then my donations will go farther. Looking at how cost-effective an organisation is means comparing their overall spending (on programs and administrative costs) to their impact, meaning overhead spending is usually already factored in!

Metrics for effective giving

Without simple evaluation measures like overhead spending, the task of charity evaluation becomes much more difficult. (Perhaps that’s why so many well-known charity evaluators choose to focus on spending habits; if they rated the impact of a charity’s programs — a task that requires considerably more research — they likely wouldn’t be able to provide ratings for as many organisations.)

But this is an area where it doesn’t make sense to go for quantity over quality. Because there are so many people in need, it’s incredibly important that our limited resources are truly helping! So let’s make sure the metrics we are using to determine efficacy are as reliable as possible.

GiveWell, a charity evaluator that focuses on program impact, takes the approach of identifying promising, evidence-based programs and then recommending charities that implement them well, a method that yields fantastic giving opportunities. In addition to consulting organisations like GiveWell, we can also use frameworks like the one explored on our choosing charities page, which is briefly summarised below (and which GiveWell’s recommended charities score quite well on!) You can also find highly-impactful organisations that score well on this framework via our Best Charities of 2022 page and through The Life You Can Save.

A Framework for Effective Giving:

1. Does the charity do work in a high-impact cause area?

A high-impact cause is generally large in scale, tractable, and relatively neglected. In other words, it has the potential to significantly impact a large number of people (scale), offers a reasonable chance at successfully making progress (tractable), and needs funding/resources (neglected).

2. Are the charities’ programs backed by rigorous evidence?

Charities that use evidence to evaluate their programs for efficacy are more likely to truly have an impact, rather than ending up in the “looks amazing on paper but does little/potentially causes harm” category

3. Is the charity cost-effective?

A charity is cost-effective if its impact greatly outweighs its cost; in other words, if it achieves a lot for relatively little. Just like you wouldn’t spend $5,000 dollars on a coffee when you can get the same cup for $5.00, we want to choose charities that make the best use of our limited resources. Of course, this last metric isn’t always so simple. Many policies/programs don’t lend themselves to gold-standard impact measures like randomised control trials, and this shouldn’t necessarily be a reason to dismiss them outright! Since reality is messy and the future is not always predictable, using a variety of tools to estimate cost-effectiveness, including concepts like hits-based giving and expected value, helps us make more informed decisions around cost-effectiveness.

So no, looking at overhead costs likely isn’t the best way for you to determine where to donate. However, there are plenty of other markers of charity excellence (like those described in the framework above) that do a better job narrowing down the overwhelming number of options out there, so we can be confident that we are truly helping the cause(s) we care about. Happy donating!