How to Squander Your Endowment: Pitfalls and Remedies
43 Pages Posted: 11 Oct 2021 Last revised: 3 Nov 2021
Date Written: October 11, 2021
University donors can contribute to endowment to make a permanent impact, given that universities are committed to investment and spending policies that preserve capital. Unfortunately, practitioner's common criterion of spending less than the expected return on endowment is known not to be sufficient to preserve capital, and we show that smoothing spending is destabilizing and exhausts wealth in finite time. These problems can be corrected even if the expected real return can go negative. We also show that compounding may neutralize the preservation-of-capital constraint in optimization models, and we discuss formulations in which preservation of capital retains its bite.
Keywords: University endowment; Spending; Capital preservation; Destroying capital; Moving average; Smooth spending; Smooth consumption; Permanent contribution
JEL Classification: G11; G23; L31
Suggested Citation: Suggested Citation