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Part of the Series Guide to PhilanthropyCreating a Charity
Private Foundations/Donor-Advised Funds
An endowment is a gift to a nonprofit organization to be used for a specific purpose.
The term endowment is also used to refer to the total investable assets of a nonprofit institution like a university. The endowment, also known as the institution's “principal” or “corpus,” is used for operations or programs that are consistent with the wishes of the donor(s).
Most endowments are designed to keep the principal amount intact while the income is used to further the cause specified by the beneficiary. A restricted endowment must be held in perpetuity, with only the income available for spending.
Endowments are typically organized as a trust, private foundation, or public charity. Many benefit educational institutions, Others go to cultural institutions, such as museums, libraries, religious organizations, private secondary schools, and service-oriented organizations such as retirement homes or hospitals.
In some cases, only a certain percentage of an endowment’s assets can be used each year so the amount withdrawn from the endowment could be a combination of interest income and principal. The ratio of principal to income can change year to year based on prevailing market rates.
Endowment funds are governed by the guidelines of three components, including an investment policy, a withdrawal policy, and a usage policy.
The investment policy lays out which types of investments a manager is permitted to make and dictates how much risk the manager can take in seeking the target return. Many endowment funds have specific investment policies built into their legal structure so that the pool of money lasts for the long term.
The endowment funds of larger universities can have hundreds, if not thousands, of smaller funds that invest pools of money in various securities or asset classes. The funds typically have long-term investment goals, such as a specific rate of return or yield. The asset allocation (or mix of investments within the fund) is designed to meet the long-term returns in the fund’s objectives.
The withdrawal policy establishes the amount the organization or institution is permitted to take out from the fund at each period or installment.
The withdrawal policy can be based on the needs of the organization and the amount of money in the fund. However, most endowments have an annual withdrawal limit.
For example, an endowment might limit the withdrawals to 5% of the total amount in the fund. Most university endowments are established to last forever and, therefore, have annual spending limits.
The usage policy establishes the purposes for which the fund can be used. Endowments, whether set up by an institution or given as a gift by donors, can have multiple uses. These include ensuring the financial health of specific departments, awarding merit scholarships or fellowships, or providing other financial assistance to students.
University chair positions or endowed professorships can be paid with the revenue from an endowment, freeing up capital that can be used to hire more faculty. These chair positions are considered prestigious and are reserved for senior faculty.
Endowments can also be established for specific disciplines, departments, or programs within universities. Smith College, for example, has an endowment for its botanical gardens, and Harvard University has more than 14,000 separate endowment funds.
There are four types of endowments:
The terms of endowments can be violated only in exceptional circumstances. If an institution is facing bankruptcy but still has assets in endowments, a court can issue a cy pres doctrine, allowing the institution to use those assets to improve its financial health while still honoring the wishes of the donor as closely as possible.
Drawing down the corpus of the endowment to pay debts or operating expenses is known as “invading” or “endowment fund invasion,” and sometimes requires court approval.
Managers of endowments have to deal with the push and pull of interests to make use of assets to forward their causes or sustainably grow their institutions. The goal of any group given the task of managing a university’s endowments is to sustainably grow the funds by reinvestment of the endowment’s earnings while contributing to the institution.
Philanthropies, a category that includes most grant-making foundations, are required by federal law to pay out 5% of their investment assets on their endowments every year for charitable purposes at the risk of losing their tax-exempt status. Private operating foundations must pay substantially all—85% or more—of their investment income. Community foundations have no requirement.
Under the Tax Cuts and Jobs Act of 2017, substantially large university endowments must pay a tax of 1.4% on net investment income. This tax is levied on endowments held by private colleges and universities with at least 500 students and net assets of $500,000 per student.
Endowments are such an integral part of U.S. academia that the size of a school’s endowment can be a fair measure of its well-being. They provide colleges and universities with the ability to fund their operating costs with sources other than tuition and provide a rainy-day fund.
Older educational institutions, such as the Ivy League schools, have been particularly successful in building extremely robust endowment funds, having the advantages of continued donations from wealthy graduates and good fund management.
Marcus Aurelius established the first recorded endowment, circa 176 AD, for the major schools of philosophy in Athens, Greece.
Harvard and other elite colleges have come under criticism for the size of their endowments. Critics have questioned their utility, likening it to hoarding.
Large endowments had been thought of as rainy-day funds for educational institutions, but during the Great Recession, many endowments cut their payouts. A 2014 study published in the American Economic Review looked closely at the incentives behind this behavior and found a trend toward an overemphasis on the health of an endowment rather than the institution as a whole.
It’s not unusual for student activists to look with a critical eye at where their colleges and universities invest their endowments. In 1977, Hampshire College divested from South African investments in protest of apartheid, a move that a large number of educational institutions in the United States followed.
More recently, three universities with multibillion-dollar endowments—Harvard, Princeton, and Stanford—declined to accept millions they were set to receive as part of a $14 billion federal aid package for higher education included in the CARES Act. Harvard University has now declined emergency COVID-19 relief money from the federal government three times, most recently $25.5 million from President Biden’s American Rescue Plan.
The oldest endowments still active today were established by King Henry VIII and his relatives. His grandmother, Countess of Richmond, established endowed chairs in divinity at Oxford and Cambridge, while Henry VIII established professorships in a variety of disciplines at Oxford and Cambridge.
According to the National Center for Education Statistics article, the top 10 U.S. universities by endowment size in 2023 were:
Harvard officials had expected the endowment to shrink in 2020 due to the impact of the pandemic on the economy and financial markets. They were wrong, though, as it returned 7.3% on its investments and actually increased a bit.
Similar fears about 2021 proved even more unfounded. Powered by a rising stock market, the endowment returned a whopping 33.6% on its investments and grew by $11.3 billion to $53.2 billion.
The fund treaded water more recently, returning -1.8% in fiscal 2022 and 0.1% in fiscal 2023.
There are thousands of specific funds within the overall endowment fund for Harvard. The funds’ asset allocation was spread out through various types of investments, including:
The endowment’s annual payout rate is typically capped. Harvard’s payout in 2023 totaled $2.2 billion.
From an investment perspective, Harvard’s endowment fund has consistently produced strong returns over the long term, although ongoing infusions of capital in the form of new endowments also drive total growth.
The endowment of a university or other nonprofit institution may be made up of many individual donations, each called an endowment. Harvard's total endowment is more than $50 billion. That fund is made up of many individual gifts, each of which comes with its own rules. For example, an individual donor may contribute a sum of money to be used strictly to fund research by the graduate Department of Anthropology.
In most cases, the administrators of endowments spend only the investment income on an endowment, not the principal of the gift. That is a common stipulation of many endowments.
An institution that has an endowment may have an internal financial manager or hire an outside firm to manage the money. In either case, the Board of Trustees of the institution sets in place the rules for investing and spending the money.
An endowment is, by definition, a gift to a non-profit institution. Any educational, charitable, religious, or scientific institution can be the recipient of an endowment. Generally, creators of endowments are high-net-worth individuals (or groups) who want to contribute to a particular cause. The endowment allows them to be highly specific about how they want their money to be used.
Some of the most prestigious universities in the U.S. have endowments of fabulous size. That may well annoy some of their students, who are paying hefty tuition fees to study there. But for better or worse, endowments can't be used to reduce everyone's tuition or even to keep the lights on. Endowments are made up of many specific gifts from individuals and groups that specify their uses. They may underwrite certain research, create a scholarship, or fund a chair.
Endowments are meant to last in perpetuity. Only the investment returns, not the underlying assets, are spent from year to year.
