Endowments are focused on preserving assets and spending power over a long period of time, often perpetuity. Economic disruption, if prolonged, can cause challenges for endowments. If endowment assets lose value, endowment board members sometimes struggle to balance their duty to preserve assets with their desire to support the organization – often in light of decreased revenue from other, non-endowment sources. In an effort to strike the right balance, endowment boards may review their spending policies to consider whether modifications are appropriate.

Spending Policy

Unlike foundations, which are required to spend a minimum amount each year, endowments are not subject to a minimum spending requirement. The endowment board has broad discretion to establish the spend rate, subject to any limitations imposed by donors. In setting a spending rate, the endowment board must act prudently in accordance with its duties of loyalty and care. For most states, a spending rate in excess of 7% creates a presumption of imprudence. This presumption is intended to protect against spending the endowment funds too quickly.

Endowments should seek to establish a spending rate that is sustainable and maintains purchasing power over a long period of time. This decision should not be made in a vacuum, but rather should be integrated with asset allocation conversations. Consider, as a simple example, an endowment that wishes to spend 5% per year. If the endowment is invested completely in fixed income, in the current market environment, it is not likely to generate the investment returns necessary to cover its expenditure. Instead, the asset allocation should be structured so that long-term investment returns will cover expenditures plus inflation.

Another goal of endowment spending policies is to smooth year-over-year market volatility. Instead of applying the spending rate to a market value that reflects one point in time, many endowments use a smoothing formula based on a rolling three-year average of quarterly market values. This method creates annual spending levels that are more predictable, making it easier for the nonprofit organization to budget and plan.

Even best-laid plans, however, are challenged during times of economic upheaval. Because the annual spending level is based on historic market values, a sudden drop in asset value may result in spending levels that exceed the spending rate in a given year. Increasingly, sophisticated endowments are running stress tests, whereby they model various scenarios to analyze the potential range of results over a period of time. The results of these stress tests can help endowments determine the impact of spending. If necessary spending will have a negative impact on the endowment, or will require the endowment to liquidate holdings, endowment boards might think creatively about meeting the spending needs, including through strategies such as traditional loans or bond issuance.


Historically, endowments could not spend below their historic dollar value (the initial funding amount plus additions). This typically is not an issue for well-established endowments, which have benefited from years of positive market returns, provided that their established spending rate has been sustainable. But newer endowments or those with more aggressive spending rates may face this issue. If so, they will need to assess whether it makes sense to spend and whether they have the flexibility to do so.

To make this determination, applicable state law and individual donor intent will need to be reviewed. Many endowments have subaccounts established by donors to support specific programs or purposes within an organization. These accounts might be subject to spending restrictions. Such restrictions might be imposed by the donor, prohibiting expenditures if the account falls below the initial funding amount. If the donor is still living, it may be possible to revisit those restrictions with the donor. If the donor is not living, court action may be required. Similar restrictions might also be imposed by state law, though many states have addressed the challenges created by these restrictions by adopting modern and more flexible legislation. These challenges underscore the importance of establishing an effective spending policy.


Nonprofits also may be concerned regarding the impact economic disruption may have on philanthropy. While this concern is less relevant to an endowment board’s core responsibilities, the impact it has on the nonprofit’s non-endowment income may lead to conversations about increasing the spending rate from the endowment. Given the desire to support the nonprofit, the endowment board will have to balance this desire with its other responsibilities.

As endowment board members consider their roles in the context of economic disruption, they might realize that the disruption itself might be unavoidable. They might shepherd the endowment through this period by evaluating the spending policy. Further, the associated challenges can be mitigated through implementation of an appropriate investment strategy.

Brown Brothers Harriman (BBH) works with endowments and foundations (E&Fs) to help manage assets and advise on spending policies, philanthropy, management of operating entities and fundraising. If you would like to discuss any topics related to E&F management or philanthropy, a BBH professional would welcome the conversation. For more information on how we are helping our E&F clients navigate issues around endowment portfolios, spending policies, operations and fundraising during the COVID-19 pandemic, please watch our recent webinar.

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