Endowment Spending Policies


Endowments are faced with competing objectives — supporting current grants while simultaneously preserving spending power for future recipients. When markets and investments generate exceptional returns, the ability to meet both goals is easy. However, during bear or volatile markets, the ability to balance appropriation versus accumulation becomes much more difficult. In challenging times, the spending policy of an endowment plays a large part in the long-term success of the endowment.


The earliest endowments date back to 12th century Europe and belonged to religious organizations that owned land. As land values and rents increased, so did the ability to increase spending. The earliest spending policies were income-only based and served as the model for modern endowment spending policies.

In the early 1900s, U.S. endowments were invested primarily in fixed income — bonds and mortgages. The income from investments, like the early European endowments, dictated spending. It wasn’t until the 1950s and 60s when there was increasing pressure for endowments to invest in equities. The impetus was twofold: higher equity returns and high inflation. Endowments primarily invested in fixed income quickly saw their purchasing power disappear.

However, endowments were reluctant to include equities in their portfolios, as traditional spending policy was dictated by income and interest. The restriction to only spend income and preserve the corpus (or protect the principal) of the endowment did not support decreasing fixed income allocations to accommodate equities. It wasn’t until 1972, when the Uniform Law Commission passed the Uniform Management of Institutional Funds Act (UMIFA) that equity allocations in endowments became more prevalent. UMIFA encouraged endowments to invest for the long-run by using a total-return approach. Total-return investing viewed portfolio growth not only from fixed income instruments but also dividends and stock appreciation.

With the inclusion of equities, portfolio values became less stable. To compensate for year-to-year fluctuations in value, smoothing methods were introduced. Instead of spending being based on a current year’s value, it was common to use an average over a period of time to reduce the volatility in spending.

No major changes to endowment spending policies occurred until the early 2000s. After a long period of exceptional stock market growth, many endowments heavily favored equities in their overall allocation. Then with the tech bubble and 9/11 in the early part of the decade, endowments were suddenly faced with great changes to spending.

To further stabilize spending, hybrid spending policies were introduced. Hybrid policies aimed to take into consideration prior year’s spending to smooth spending and current market value to preserve assets. The difference between hybrid policies and earlier smoothing models was the flexibility to prioritize one goal over the other depending on the endowment’s needs.

In 2006, the Uniform Law Commission proposed the Uniform Prudent Management of Institutional Funds Act (UPMIFA). UPMIFA gave more flexibility to board members and trustees to make spending decisions by doing two things:

  • Eliminating the “Historic Dollar Value” floor so that spending could dip into the corpus of an endowment if necessary
  • Providing seven factors to consider when making spending decisions:
    • Duration and preservation of the endowment fund
    • The purposes of the institution and the endowment fund
    • General economic conditions
    • The possible effect of inflation or deflation
    • The expected total return from income and the appreciation of investments
    • Other resources of the institution
    • The investment policy of the institution

History of Spending Policies

history of spending policies

Source: Endowment Spending Policies Since the Passage of UPMIFA. Callan Investments Institute Research, April 2010.

Source for S&P 500 Index returns: Dimensional Fund Advisors. Indices are not available for direct investment, Their performance does not reflect the expenses associated with the management of an actual portfolio nor do indices represent results of actual trading. Information from sources deemed reliable, but its accuracy cannot be guaranteed. Performance is historical and does not guarantee future results.

Current Spending Policies

There are many types of endowment spending policies in use today. The most common can be categorized into four main categories: simple, inflation-based, smoothing and hybrid.


Simple policies are easy to understand and implement. Typically, a flat spending amount or flat spending rate is applied annually to the market value of the portfolio. Although UMIFA encouraged foundations to invest using a total-return approach, some institutions still employ the traditional income-only (interest, dividends) spending model. Fixed rate and income-only policies are most likely to be used with institutions most concerned with preserving principal. The downside is spending can be highly volatile or insufficient from year to year.


Inflation-based methodologies are similar to simple polices with the exception of factoring in possible or actual inflation. By applying an inflation adjustment, spending can keep pace with real changes in needs.

Inflation-protected policies set spending to grow either by a fixed expected inflation amount, typically 2–3 percent, or by pegging spending to an actual measurement of inflation, typically CPI.


Smoothing policies are used when preservation of the endowment is still the primary objective but the stability of spending also becomes an

issue. The most common form of a smoothing policy is the moving average method.

The moving average method is the most widely used spending policy. Approximately 75 percent of institutions use some form of the moving average. In a recent survey of foundations, over the past 10 years, the average spend rate has been between 4.0 percent and 5.5 percent, applied to a moving average of a defined period, typically three years or 12 quarters. One benefit of a moving average policy is that spending tends to be more stable than with traditional income-only or fixed-rate policies. At the same time, it favors the long-run preservation of the corpus, assuming an appropriate target spending level is chosen.

The main criticism of the moving average is that endowments tend to overspend in down markets and underspend in upward trending markets. However, a Vanguard study found moving average policies to be most successful in terms of preserving endowment value and sustaining future spending.


Hybrid methods aren’t as widely used but receive a lot of attention due to the fact that several of the top U.S. endowments, which often serve as a model for other institutions, employ hybrid spending methods. Approximately 12–15 percent of institutions over $500 million in assets use some form of a hybrid spending policy. A hybrid policy combines two spending policies and weights the importance of each spending policy depending on the overall goals of the organization. This allows for greater flexibility in prioritizing the objectives of an endowment.

One of the most well-known endowments, Yale University, uses a hybrid method that takes into account the prior year’s spending for stable budgeting purposes and market value to add spending off of new contributions and market returns. The Yale endowment currently employs the following spending rule:

80% x (Prior Year’s Spending x [1 + Inflation]) + 20% x (Current Portfolio Value x Spend Rate)

By weighting prior year’s spending more heavily, Yale puts more emphasis on having consistent spending from year to year, since a significant amount of Yale’s annual budget is provided by the endowment.

Unlike moving average rules, the hybrid method introduces some complexity to spending policy decisions. After deciding what combination of spending rules will be used, committee members must then determine the optimal balance between the competing spending objectives. Initial allocations may need future adjustments if the formula isn’t appropriate.

Even Yale has changed its allocations three times since 1995 to reflect changes in budget needs, asset allocation, liquidity and markets.

Choosing a Spending Policy

Different methodologies serve different purposes. Some weight preservation of the corpus more heavily, while others emphasize short-term spending stability. Policies should account for the overall philosophy of the sponsor and goals and objectives of the endowment.

Varying Results

Historic market data offers a method to evaluate spending policy performance. The chart below illustrates how various spending policies would have behaved over the past 15 years (1995–2009) if the portfolio assets were invested in a 60 percent S&P 500 Index and 40 percent Barclay’s Capital US Government/Credit Intermediate Bond Index.

Comparison of Spending Policies from 1995–2009

comparision of spending 1995-2009

For illustrative purposes only.

Source: Dimensional Fund Advisors. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio nor do indices represent results of actual trading. Information from sources deemed reliable, but its accuracy cannot be guaranteed. Performance is historical and does not guarantee future results.

Based on annual returns for 60 percent S&P 500 Index and 40 percent Barclay’s Intermediate/Government Credit Bond Index. Assumes initial portfolio is $10 million. Hybrid is 80% previous year + inflation (set at 3 percent) and 20 percent of 5 percent market value.

The simple method of taking just 5 percent of the portfolio value each year fluctuates greatly with market volatility. From a peak spending of more than $700,000, spending then falls by more than a third in 2007.

The smoothing method is still subject to market volatility but with smaller swings in spending. It experienced a peak of almost $700,000 and then a smaller drop of about 28 percent in 2009. The criticism that smoothing lags market peaks and drops can be seen in comparison to the blue “simple” spending line.

Using the Yale weightings, the hybrid method is clearly smoother over the 15-year period than the other two methods, the direct result of over-weighting the previous year’s spending by 80 percent. For Yale, where a large percentage of the annual budget is drawn from the endowment, it makes sense to place a greater emphasis on smooth spending. On the other hand, in the absence of a steady stream of support and income and assuming the same spending rate for each method, the hybrid method using Yale’s weights depletes its endowment more quickly than the endowments using a simple or smoothing method.


No one method will be the solution for every endowment. It is important for a board to understand the following:

  • What is the overall mission/goal of the organization?
  • What is the priority of the underlying objectives?
  • What is the appropriate risk profile or risk tolerance? In other words, can the board identify the organization’s ability, willingness and need to take risk which guides spending?

Board and staff members should also remember that once a spending policy is in place, it is good practice to review the policy each year for changes in priorities of objectives, significant impacts to the value of the portfolio (positive or negative) or even legal changes. In addition, using the seven factors outlined in UPIMFA can help navigate spending during volatile markets.

The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.

© 2012, The BAM ALLIANCE

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