0.13 Chapter ten: the complexities of nonprofit financing  (Page 9/10)

Spending rate

The final element of endowment management concerns the use of investment returns to help pay operating expenses. When the Society adopted a total return philosophy in 1967, the spending rate established by the board of trustees was 5 percent of the three-year moving average of the market value of the unrestricted endowment.

An example will help illustrate how a spending rate works in practice. At the end of 1971, the three-year moving average of the market value of the Society's endowment for 1969, 1970, and 1971 was $13.88 million. At a spending rate of 5 percent, the Society was authorized to spend $694,000. Dividend and interest income, however, amounted to only $450,000. To make up the difference, the Society spent an additional $244,000 of realized gains and thereby reached the authorized spending limit.

An estimate of the Society's total return in 1971 is 16.4 percent. Couldn't the Society have spent more than 5 percent of the endowment's market value during the year? If its goal were simply to maintain the real purchasing power of the endowment for that single year, the answer is yes. The inflation rate in 1971 (calculated from the growth in GDP) was 5.4 percent. Consequently, the Society could have spent an additional 6.0 percent (16.4 percent minus 5 percent minus 5.4 per­cent), or $833,000, and exactly maintained the real value of its endowment.

For a period, the Society kept its spending from the endowment within the 5 percent constraint; however, in 1974, pressured by a variety of financial factors, the Society spent 7 percent of the market value of its endowment. That action set a very bad precedent. By the mid 1980s, the Society appeared to ignore entirely the maximum spending rate established as part of the total return policy.

Without an enforced spending limit, the total return concept is not an en­dowment management philosophy; it becomes an improper justification for liq­uidating endowment principal. In 1985, the Society withdrew a total of $2.7 million from the endowment to pay for operations, an astounding 24.7 percent of the endowment's total market value. In 1986, it spent 15.5 percent. And in 1987, the Society spent an amazing 28.1 percent of its total endowment portfolio.