What is an Endowment?

Endowments represent money or other financial assets that are donated to universities or colleges and are meant to be invested to grow the principal and provide additional income for future investing and expenditures. Typically, endowment funds follow a fairly strict set of long-term guidelines dictating the asset allocation that will yield the targeted return without taking on too much risk.

Most endowments have guidelines stating how much of each year's investment income can be spent. For many universities, this amount is about 5% of the endowment's total asset value. Because some of the more coveted schools, such as Harvard, have endowments worth billions of dollars, this 5% can equal a large sum of money.

How Endowments Work

An endowment is a donation of money or property to a non-profit organization, which uses the resulting investment income for a specific purpose. "Endowment" can also refer to the total of a non-profit institution's investable assets, also known as "principal" or "corpus," which is meant to be used for operations or programs that are consistent with the wishes of the donor. Most endowments are designed to keep the principal amount intact while using the investment income for charitable efforts.

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 both Oxford and Cambridge, while Henry VIII established professorships in a variety of disciplines at both Oxford and Cambridge. Marcus Aurelius established the first recorded endowment for the major schools of philosophy in Athens circa 176 AD.

Endowment donors can sometimes restrict how the schools spend this money with an investment policy statement (ISP). For example, donors can decide to use a portion of an endowment's scheduled income on a merit-based or need-based scholarship. Another standard restrictive use of an endowment's income is to provide funding for endowed professorships, which are used to attract world-class educators.

Other than these restrictions, universities can use the rest of the allotted spending amount as standard income. Decisions about whether it should be spent on hiring professors, upgrading/repairing facilities or funding more scholarships are left up to school administrators. An endowment's investment income can also significantly lower tuition costs for students. For example, if a university's endowment yields a total of $150 million and has a 5% spending limit, this would provide $7.5 million of available income. If the university had originally budgeted $5.5 million in endowment funds, this would mean that the excess $2 million could be used to pay other debts/expenses and the savings could be passed on to students. 

However, because universities depend on investment returns for supplementary income, there could be trouble if the investments do not yield a suitable amount of returns. Therefore, most endowments are run by professionals to ensure the investments made are in line with the aforementioned policy allocation.

Key Takeaways

  • An endowment is a donation of money or property to a non-profit organization, which uses the resulting investment income for a specific purpose.
  • Endowment funds are established in perpetuity, meaning that no end-date for the fund is set.
  • Endowments are often used by universities and non-profit organizations to fund their ongoing operations.

Endowment Types

There are four different types of endowments: unrestricted, term, quasi and restricted. 

  1. Term endowments usually stipulate that only after a period of time or a certain event can the principal be expended.
  2. Unrestricted endowments are assets that can be spent, saved, invested and distributed at the discretion of the institution receiving the gift.
  3. A quasi-endowment is a donation by an individual or institution, given with the intent of having that fund serve a specific purpose. The principal is typically retained while the earnings are expended or distributed per specifications of the donor. These endowments are usually started by the institutions that benefit from them via internal transfers or by using unrestricted endowments already given to the institution.
  4. Restricted endowments have their principal held in perpetuity, while the earnings from the invested assets are expended per the donor’s specification.

Except in a few circumstances, the terms of these endowments cannot be violated. If an institution is near bankruptcy or has declared it, but still has assets in endowments, a court can issue a doctrine of cy-près so the institution can use those assets toward better 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 invasion" and sometimes requires state approval.

Criticisms of Endowments

Harvard University and other elite higher educational institutions have come under criticism for the size of their endowments. Critics have questioned the utility of large, multi-billion-dollar endowments, likening it to hoarding, especially as tuition costs began rising at the end of the 20th century. Large endowments had been thought of as rainy-day funds for educational institutions, but during the 2008 recession, many endowments cut their payouts. A 2014 American Economic Review study looked closely at the incentives behind this behavior and found that there has been 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. Advocating for divestment from industries and countries that students find morally compromised is still common among student activists, though the practice is evolving to improve efficacy.