Spending Policies

There are two basic ways to distribute money from an endowment fund: an “income-only” policy, and a “total return” policy. In the “income only” policy the board spends only the money earned on debt (interest) or received from dividends. In the “total return” policy the board considers the income earned, dividends received, and capital appreciation/depreciation of the investments, thus “total.”

Using the “total return” policy the board will need to establish a “spending rule” which is usually stated as a fixed percentage of an average net asset value of the funds over a period of years. The current average percentage selected by most churches is between 3% and 5%. It is usually applied to a rolling three-year average value of the endowment fund taken at the end of the previous 12 quarters. If you are just starting the fund, you could apply the percentage to the average value of the fund for four quarters, then eight quarters, and ultimately 12 quarters.

By restricting the draw to a fixed percentage, and applying it to a rolling average value of the fund, the “total return” policy should capture the ups and downs of the market (in terms of appreciation/depreciation) and over time thereby maintain the spending power of the endowment fund.

If you use an “income only” policy you may be inclined to invest in more fixed income investments so as to generate more “income” and miss out on capital appreciation. Or, if you enjoy significant capital appreciation but relatively little income generation, you will begin to see the value of the fund grow, but will not see much growth in the money available for expenditure.

One advantage of using the “total return” policy is that you are able to spend some of both the income received and capital appreciation. The discipline of setting an annual spending rule helps to preserve the fund’s spending power.

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