Most permanent endowment funds (PEF’s) are meant to exist in perpetuity. This is usually accomplished by allowing only the earnings to be spent. Oftentimes, the use of the earnings is also restricted. Creating a budget is the best tool for effectively using limited funds, and a budget is more easily developed when there is a Spending Policy.
A spending policy is a set of guidelines adopted by an organization that outline how that organization will spend from their investment or investment earnings to help fund the operations that support the mission.
Tension can arise when the spending policy conflicts with protecting the principal of the PEF. Using the following factors can help strike a balance between current cash needs (the budget) and investment objectives (longevity of principal) for the future.
Know the core mission.What will the earnings help fund?
Establish a budget to accomplish the mission
Estimate year-to-year spending variance
Determine risk tolerance and timelines for the investment based upon variances
Use a spending model to help determine the amount of funds that will be available
Examples of Spending Models
Simple – a flat spending amount tied to the annual market value of the investment portfolio
Inflation-based – the simple model with an adjustment for inflation (actual or estimated)
Smoothing – uses the average market value of the investment portfolio over the last three years and multiplies it by the spending rate to determine the average annual spending amount
Hybrid – combines two spending policies, generally weighing recent year spending levels more heavily than earlier years
Start the next year with reviewing the success of last year.
Was the mission accomplished?
What was the variance of actual expenses compared to the budget?
Evaluate the effectiveness of the spending model, adjust and update
Dana Aycox, Controller
United Methodist Foundation
Photo by Hello I'm Nik on Unsplash