Like many of my peers, I’ve thrown around a phrase that goes something like this:
“We’ve got a $27-billion endowment. You’d think we could afford to ____.”
It’s a sentence that seems logical in most contexts. I spend maybe $300 on course materials each semester — a lot for me, but nothing for the endowment. While it instinctually makes sense to claim that Yale could be spending more on whatever is bothering us that day, there must be some logic behind the endowment’s rate of spending. How much gets spent and on what?
Readily visible on the endowment’s website are general statistics about the institutional-level recipients of endowment funds: Endowment funds account for a full 34 percent of the University’s operations, covering, for example, 62 percent of the Yale University Art Gallery’s budget and almost 75 percent of the library system. Yale’s University-wide financial aid program receives around $370 million from the endowment — roughly 85 percent of undergraduate financial aid ($150 million) is included in that number.
But, while those numbers are objectively high, couldn’t we do more? Roughly 15 percent of Yale undergraduates graduate with an average debt of $14,000. Though I’ve argued that students should overborrow in college to invest money long-term, these students surely, generally, borrow out of financial need. (43 percent of Yale’s graduates in 2005 carried an average debt of $17,000 in today’s dollars, so let’s remember our victories!) Furthermore, I’m sure that any department at Yale could suggest additional, worthwhile endeavors that would warrant more generous spending.
One limiting factor is that about 84 percent of the endowment is technically “endowed,” or made up of “gifts restricted by donors to provide long-term funding for designated purposes.” So, even if we had $27 billion in a checking account, Yale would be limited in its ability to spend more in any given area. A year’s worth of financial aid for Yale College costs the same amount as the Schwarzman Center’s renovation. Donor wishes matter, and they should — respect for their intentions incentivizes donations to the University. Just 17 percent of the endowment falls into the University-wide category of “fellowships, scholarships and prizes.”
But, restrictions aside, the endowment’s rate of spending is fixed by a single formula. While Yale aims to spend 5.25 percent, that number varies according to a “smoothing rule.” The rule states that endowment spending each year is the sum of 80 percent of the previous year’s spending and 20 percent of the targeted long-term spending rate applied to the endowment’s value two years prior. In fiscal 2016, the endowment spent about $1.2 billion, or 4.7 percent of its fiscal 2015 year-end value. Also in 2016, the endowment grew by 3.4 percent. Spending exceeded growth: a financial loss, of sorts, but to the benefit of the current University population. In fiscal 2015, on the other hand, endowment growth exceeded spending by about 7 percent.
While that may sound complicated, the smoothing rule ultimately just allows Yale to budget and plan consistently, regardless of short-term stock market volatility. Spending is always between 4 percent and 6.5 percent and fluctuates less than the value of the endowment itself. Though endowment spending has essentially doubled over the last decade, what stops us from setting the target spending rate higher than 5.25 percent?
An often-cited rule of thumb for retirees is the “4 percent rule.” It essentially states some version of, “A portfolio will grow on average by 7 percent each year, and inflation will average 3 percent: You can withdraw the difference of 4 percent.” It’s a notably accessible and effective rule that, in theory, preserves the purchasing power of your grandparents’ nest egg and allows them to spend a consistent amount each year. Yale is a retiree who must financially prepare for immortality. Overspending on today’s generation means depriving the next. The target spending of 5.25 percent represents the Yale Investments Office’s calculated and conservative expectations for future growth, adjusted for inflation.
But the endowment hasn’t just preserved purchasing power; it has grown far faster than inflation has for decades. That unusual growth, driven by the living forefather of institutional investing, David Swensen, leaves some grumbling in the shadow of Yale’s colossal wealth. But spectacular growth, however well-managed, does not last forever. Yale spends conservatively so that the endowment is available in perpetuity for future generations’ needs and, perhaps, desires to spend more than we do today. And there must a be a stopping point at which Yale determines that the endowment has grown far larger than will ever be necessary. But, apparently, $27 billion is not that threshold.
Louis Defelice is a junior in Jonathan Edwards College and the creator of the financial website www.wonderlearninvest.com . Contact him at firstname.lastname@example.org .