While many are inclined to measure the success of an endowment by its size and growth, the true value of an endowment lies in its ability to create long-term financial sustainability for nonprofits — carrying it through times of market volatility and changing funding environments. A well-designed spending policy is arguably the most consequential component of this success, as it governs the delicate balance between meeting today's funding needs and preserving the purchasing power of the endowment for tomorrow.
The spending policy, which is a key component of the investment policy statement (IPS), provides a disciplined framework for annual distributions, helps dilute the effects of market volatility on operating budgets and aligns spending decisions with the endowment's long-term investment strategy and return expectations.
Ultimately, the success of an endowment is not only determined by investment returns, but by its ability to provide reliable, sustainable support for the organization over time. This paper outlines four key steps nonprofit leaders can take to develop and maintain an effective spending policy that advances both present-day priorities and long-term financial sustainability.
1. Establish an appropriate return objective
When establishing a return objective, it is important to determine the amount the endowment needs to earn each year to support the organization’s long-term goals. It should reflect the long-term investment growth needed to provide annual funding for the organization, keep pace with rising costs (inflation), cover investment expenses and maintain the value of the endowment for future generations. This target helps to balance current funding needs with the responsibility to sustain the endowment for years to come.
Figure 1 shows an example of how an organization may calculate its return objective, considering its distribution rate, inflation and fees. While the distribution and its rate will vary, most nonprofit organizations are looking for distributions to last in perpetuity. To preserve that purchasing power, inflation and fees must be incorporated into the distribution/spending policy rate in order to calculate a minimum return objective that will achieve this goal.
Figura 1. Ejemplo de cálculo de objetivo de rendimiento
Distribución | 4.25 % del valor de mercado |
Inflación | 2.00 % a largo plazo |
Cargos | 0.50 % del valor de mercado |
Objetivo de rendimiento | 4.25% + 2.00% + 0.50% = 6.75% |
In the Figure 1 example, the portfolio needs to generate a long-term return of 6.75% to support annual spending, keep up with inflation and preserve the endowment for the future. This calculation will serve as the first step in building an investment strategy and will guide subsequent decisions, such as asset allocation, by making sure the portfolio takes on only as much risk as necessary. Without a clear target, the portfolio could become too aggressive, exposing the organization to unnecessary volatility, or too conservative, eventually making it difficult to maintain the endowment's purchasing power. The return objective serves as a meaningful measurement for the investment program, helping the board and investment advisor determine whether the endowment is on track.
2. Create savvy spending rules
Hay tres variables clave que se deben considerar con respecto a las reglas de gasto:
- ¿Será la distribución un porcentaje del valor de mercado de la cartera, o será un monto fijo?
- How is the portfolio market value determined? (e.g., at a specific point in time, an average over periods, etc.)
- Will spending change year to year and what factors will determine those changes?
Spending rules create formal guidelines for distributions. While the rules may vary in complexity based on the organization's needs and circumstances, good stewardship of nonprofit assets requires a clear and consistent policy. Figure 2 outlines the five most common spending rules. Even though each approach has its advantages, there is no one best method. The most appropriate spending is the one that best aligns with the organization's mission, financial needs, and long-term objectives.
Figure 2. Five common spending rules
Política | Definición |
Tasa de gasto simple | Los gastos son iguales a la tasa de gastos especificada multiplicada por el valor de mercado del período inicial. Por ejemplo: “The annual distribution will be determined based on 4% of the market value at the beginning of the fiscal year.”
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Rolling multi-period average of the Uniform Prudent Management of Institutional Funds Act (UPMIFA) | Los gastos son iguales a la tasa de gastos multiplicada por el promedio de los valores de mercado de los períodos anteriores. This method reduces the volatility of required distributions year over year. Por ejemplo: “The annual distribution will be determined based on 4% of the average market value over the trailing 12 quarters.”
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Regla de gasto geométrico | Spending in the current period is equal to a) previous year’s distribution adjusted for inflation multiplied by a smoothing rate (used to further reduce volatility, i.e., 0.7); plus, b) the beginning market value of the portfolio multiplied by the spending rate and the residual of the smoothing rate (i.e., 0.3 = 1 – 0.7). Por ejemplo: “The annual distribution will be determined using a weighted formula equal to 70% of the prior year’s distribution adjusted for inflation and 30% of 4% of the market value at the beginning of the fiscal year.”
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Regla vinculada a la inflación | Comience con un monto fijo en dólares (típicamente determinado por cierto porcentaje del valor de mercado de arrastre) y el monto fijo se ajusta cada año por medio de un índice de inflación. Por ejemplo: “The annual distribution will initially be set at 4% of the average market value over the trailing 12 quarters and increased each fiscal year by the rate of inflation as measured by the Consumer Price Index.”
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Regla híbrida | Parte del monto de gasto anual se determina mediante un ajuste por inflación de los gastos del año anterior, mientras que el saldo se determina mediante la aplicación de una tasa fija al valor de mercado de la cartera. Por ejemplo: “The annual distribution will be determined using a blended formula equal to 70% of the prior year’s distribution adjusted for inflation and 30% of 4% of the market value over the trailing 12 quarters.”
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Fuente: PNC
3. Analice los probables resultados de la cartera
The size and frequency of distributions have measurable impacts on investment results. Simply put, if an endowment consistently spends more than it earns, it will eventually run out of funds. Conversely, a portfolio that earns more than it spends, while also covering fees and inflation, will be more likely to grow and maintain purchasing power in the long run. There are three key factors that influence this outcome: the size of the distribution, the frequency of the distribution and the return objective of the portfolio.
Tamaño de distribución
All else being equal, an endowment that distributes less each year will generally have a higher value with time than one that distributes more. This is because more assets remain invested and have the opportunity to grow and compound. As a result, even small differences in spending rates can have a significant impact on an endowment's long-term value.
Consider the simplified example in Figure 3, which assumes a portfolio of $100 growing at 6% annually. En tan solo tres años, incluso una pequeña diferencia en el tamaño de la distribución anual produce un efecto notorio en el valor final de la cartera. This difference would only become more pronounced over 10 years, 20 years or more. This example highlights how larger distributions can impact an organization’s ability to sustain itself in the future.
| Comience con | Año 1 | Año 2 | Año 3 |
Distribución de $2 | $100.00 | $104.00 | $108.24 | $112.73 |
Distribución de $5 | $100.00 | $101.00 | $102.06 | $103.18 |
Diferencia | $0.00 | $3.00 | $6.18 | $9.55 |
Frecuencia de distribución
How often an organization takes distributions from its endowment can influence both the spending policy and asset allocation. Organizations that make regular distributions need to ensure they have enough cash and liquid investments available to meet those obligations. For example, an endowment that distributes funds monthly may need to hold more readily accessible assets than one that makes distributions annually. While larger portfolios may be able to maintain allocations to less liquid strategies (i.e., traditional alternative investments) and still meet spending requirements, portfolios with greater liquidity demands may require higher allocations to assets that can be quickly converted to cash.
La predictibilidad también es importante. When spending needs are known in advance and occur on a regular schedule, investment assets can be structured to support those cash flow requirements more efficiently than when distributions occur unexpectedly or at irregular intervals.
Distribution return objectives
The return objective serves as the north star for the portfolio’s construction. It is important that return objectives support minimum required distributions, when applicable. Scenario analysis can help boards and investment committees understand the likelihood of achieving the return objective under different market conditions and spending rates. By testing various assumptions, organizations can better understand the trade-offs between current spending needs and long-term portfolio sustainability.
The size, frequency and return objective of the distribution are interconnected in determining an appropriate spending policy.
4. Plan for periodic reviews
Along with regular IPS reviews, organizations should establish a process to review and maintain the spending or distribution policy on a regular basis — at least annually. From organizations’ financial objectives to the broader investment markets — circumstances are continually changing. Periodically evaluating the spending policy helps confirm that it remains appropriate as organizational objectives and market conditions evolve.
As new board or investment committee members join the organization, they should be introduced to the investment and spending policies as part of onboarding. This will help the organization keep strategic continuity across leadership succession.
Conclusión
A spending policy is much more than a formula for determining how much can be spent each year. It serves as a framework for balancing current impact with future sustainability. It is a critical link between an organization's mission, financial needs and long-term investment strategy. It influences investment return objectives, portfolio construction, liquidity management and the long-term sustainability of the endowment. A thoughtful spending policy helps balance the needs of today's beneficiaries with the responsibility of preserving resources for future generations. By establishing clear and thoughtful spending guidelines and reviewing them regularly, nonprofit leaders can strengthen their stewardship of endowment assets and help ensure that those assets continue to provide meaningful, lasting support for the organization's mission for generations to come.
Grupo de estrategias y soluciones para organizaciones sin fines de lucro
El Grupo de estrategias y soluciones para organizaciones sin fines de lucro de PNC sirve como un socio dedicado que tiene el compromiso de empoderar a las organizaciones sin fines de lucro para que logren sus misiones. Al combinar la experiencia nacional con el conocimiento local, ofrecemos educación integral y asesoramiento sobre temas de gobierno, filantropía y sostenibilidad financiera, con un enfoque que va más allá de la gestión de activos a fin de brindar perspectivas viables que aborden los desafíos más apremiantes a los que se enfrentan las organizaciones sin fines de lucro. Gracias a nuestros fuertes vínculos con la comunidad, nuestra experiencia de liderazgo práctico en cuestiones de organizaciones sin fines de lucro y nuestra sólida presencia en el mercado local, ofrecemos soluciones significativas que optimizan los recursos y generan un impacto sostenible. Para obtener más información, comuníquese con el equipo al IAMNonprofitStrategy@pnc.com.
