NCPA - National Center for Policy Analysis

What Are University Endowments For?

April 1, 2011

The wealth of American colleges is massive.  Sixty-two schools have endowments in excess of $1 billion.  Many nonprofit colleges hold substantial funds in an "endowment" with no intention of ever spending any of the principal.  In fact, they often do not spend all the income their endowment generates in order to protect the endowment's purchasing power against inflation, says Vance H. Fried, the Riata Professor of Entrepreneurship at Oklahoma State University.

  • To illustrate, let's say a donor has given $10,000 for a scholarship at a state university.
  • That sum would pay full tuition for one student for one year.
  • But if the donation is treated as a perpetual endowment and the endowment assumes a 4.5 percent real rate of return, then in the first year only $450 will be paid out to a student as a scholarship.
  • If there is any endowment income in excess of the $450 payout, it will be added to the endowment's principal.
  • In the next year the scholarship payout will still be at 4.5 percent but it will be figured on the higher principal amount.
  • The goal is for payouts to go on forever and gradually increase in amount to match inflation.
  • The purpose of a perpetual endowment is to provide very small annual payouts in perpetuity rather than one meaningful payout today.

Why do colleges and universities behave this way?  To sum up the positives, it makes economic sense to have some endowment set aside for liquidity reasons, for smoothing out the expenditure of big donations, and in perpetuity if donors demand it. 

However, many college endowments far exceed this amount -- and have an explicit goal of getting even bigger.  Colleges argue the benefits of today's endowment should be shared equally between today's generation of students and future generations.  But the task of preserving financial wealth for future generations is for a trust company, not a college.  Colleges and universities best serve future generations by devoting their resources to their educational mission in the present, says Fried.

Source: Vance Fried, "The Endowment Trap," Pope Center for Higher Education Policy, March 29, 2011.

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