30/05/2024

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How Do Endowments Work? 4 Best Tips For Managing Them

How Do Endowments Work? 4 Best Tips For Managing Them

Many parents know that getting their child enrolled in a private school means spending hefty amounts of money paying tuition fees.

Believe it or not, even some private schools’ tuition fees range up to six-digit figures. Despite the overwhelming tuition fees, these private schools need additional funds. Besides, private schools raise funds through donations, endowments, annual fund programs, and capital campaigns. 

The protection and management of endowed funds require meticulous attention, rigorous planning, and a strategic approach. Some private schools have the discipline to follow these practices. Others don’t pay enough attention to manage them successfully.

Endowment funds are one of the most important assets that private schools possess. It has an impactful role in the school’s annual budget. 

Private schools receive enormous amounts of endowments every year, out of which they spend 4.5 percent to meet certain expenses such as teachers’ salaries, operating expenses, and other overhead costs. The remaining amount is reinvested in the form of an endowment.

Though different schools follow different plans and policies for managing their endowment fund, their reason is similar- financial sustainability. 

The endowment is a crucial asset that owns a private institution that needs to be managed properly. But before moving further to explore the best practices, let’s discuss why these institutions need endowment funds and how it works.

How do endowments work?

Endowments, essentially, are like self-sustaining piggy banks for organizations, often non-profits like universities, hospitals, or foundations.

They are pools of donations (cash, stocks, property) invested strategically to generate income over the long term. This income is then used to support the organization’s mission and goals, but not in the “spend it all today” way.

Here’s how they work:

  • Investing: The initial donations and any subsequent contributions are carefully invested in a diverse portfolio of assets like stocks, bonds, real estate, etc. This aims for long-term growth while managing risk.
  • Spending policy: Endowments have spending policies that determine how much of the investment income can be used each year. This is usually a small percentage (like 4-5%) of the average fund value over several years. This ensures the principal (original donated amount) remains intact and continues to grow.
  • Income distribution: The income generated from the investments is then distributed according to the endowment’s purpose. This could be scholarships for students, research grants, faculty positions, building maintenance, or whatever aligns with the donor’s wishes or the organization’s broader goals.
  • Sustainability: The key is to strike a balance between using the income for current needs and preserving the principal for future generations. This ensures the endowment’s long-term sustainability and its ability to support the organization’s mission indefinitely.

Think of it like planting a fruit tree. You don’t eat all the fruit immediately; you tend to the tree, letting it grow bigger and stronger, knowing it will continue to bear fruit for years to come. That’s the power of an endowment.

Private School Endowment Funds: 4 Effective Management Tips

How much do endowments pay out?

The amount an endowment pays depends on several factors, making it difficult to give a single answer. Here’s a breakdown of the key influences:

  • Investment performance: The endowment’s return on investment (ROI) directly impacts the payout amount. Higher returns mean more income is available for distribution.
  • Spending policy: Most endowments have a spending policy that determines what percentage of the average fund value over several years can be used annually. This percentage typically ranges from 4 to 5 percent but can vary depending on the organization and its goals.
  • Size of the endowment: Naturally, larger endowments will have a larger pool of income to distribute, resulting in potentially higher payouts.
  • Specific purpose of the endowment: Some endowments are restricted to specific uses, like scholarships or research grants. The payout amount will be allocated towards those specific purposes.
  • Economic conditions: During economic downturns, investment returns may be lower, leading to smaller payouts. Conversely, strong economic periods can generate higher returns and larger payouts.

Here are some examples to illustrate the range:

  • Harvard University’s endowment, the largest in the world at over $40 billion, has a spending policy of about 5 percent. This translates to roughly $2 billion annually, which supports various initiatives like scholarships, research, and faculty positions.
  • A smaller private school with a $50 million endowment might have a 4 percent spending policy, resulting in a $2 million annual payout for financial aid, faculty salaries, or facility upgrades.
  • A research foundation with a $10 million endowment focused on climate change might have a more aggressive spending policy of 7 percent, leading to $700,000 annually for research grants and projects.

Ultimately, understanding how much an endowment pays out requires considering the specific context of the endowment, its investment performance, and its spending policy.

Why Do Private Schools Need Endowment Funds?

Private schools offer an easy target for the media that runs stories of enormous funds with private institutions. This misinformation about private schools creates a feeling of jealousy among readers and listeners with no particular knowledge.

There are numerous misconceptions about it. However, endowment funds are a great source of revenue for private schools to operate properly. Because apart from these funds, the only income left with private schools is tuition fees.

Believe it or not, whatever private school earns from the admissions barely covers all the expenses a school has to incur. 

Even the Private School Review has stated that these private schools can be financially fragile, and as they have two income streams tuition and fees that do not cover all the expenses a school has. Schools have numerous expenses, including salaries, insurance, utilities, and other miscellaneous expenses.

Certain private institutions offer financial aid for students who can not afford hefty tuition fees. When calculating the school’s budget, numerous factors are not even given emphasis, much like redoing the playing field, repairing the school bus, buying a new school bus, and much more. These small expenses add up to form a huge expense, which increases the need for more money.

Private School Endowment Funds: 4 Effective Management Tips

How Does Private School Endowment Work? 

A private school endowment is just like a savings account. Instead of putting money into a savings account by yourself, the only difference is that generous donors donate good amounts as substantial gifts. The schools thus invest the whole principal amount received as gifts from alumni over the year.

The investment income will be used as designated by the donor. Usually, the trustees emphasize conservative investment strategies.

For instance, if a generous donor has donated a sum of $2,00,000 to the school. The school will invest the amount according to a conservative investment strategy or any other the board has agreed upon.

Let’s say the investment returns are 10 percent. Furthermore, the school will use $20,000 for purposes the donor designated the donation for and keep the rest for legitimate emergency needs. 

The principal amount of the endowment remains untouched until an emergency occurs. Till then, only the investment return is used. For better protection and growth of these investments, schools should follow proper plans and procedures.

There is no specific law that says how schools should manage these funds, but school boards put some protocols for efficiently managing it. 

Many endowment fund providers put restrictions on using these funds and keep track of where these funds are being utilized. Therefore, schools remain cautious of their spending and keep records of them too.  

Private School Endowment Funds: 4 Effective Management Tips

How Much Private School Endowment Fund Is Enough?

Endowment funds help maintain financial equilibrium, which is why private schools need them. But the question that arises is how much endowment is enough for the schools and universities?

There can be no bar to the amount of endowment an institution is getting as it is an additional gift to the campus from the alumni. For instance, Harvard University’s endowment is over $14 billion approximately. Private schools with good endowments continue to record strong growth and increased personal wealth. 

If the private schools are getting the optimal level of support for the operating budget as an endowment, the school should identify the most support areas. Let’s discuss further how the endowment can be managed effectively.

Best Practices For Managing Private School Endowments

Here are some best practices to ensure effective management of the endowment funds in private schools: 

1. Implement Governance Structure

The private institution should be responsible for the growth and protection of endowment funds. Besides, how these institutions execute them is equally imperative.

It is a fiduciary responsibility that needs to be delegated to a qualified financial committee. With their practical knowledge in the field, it will be easier for them to establish and implement a comprehensive investment strategy. The management of the school provides the needed support, and investment advisors make decisions considering them.  

Some private institutions outsource their investment services, and others have investment officers on staff. The schools that outsource these services maintain proper documentation of the process.

To ensure appropriate law adherence, legal counsel is appointed to review all the policies and procedures followed. 

2. Adequate Monitoring

Every institution having endowment funds should responsibly manage its investment. They should implement particular policies and procedures and check timely if they are being followed. The Uniform Prudent Management of Institutional Funds Act (UPMIFA) has advised criteria guiding the endowment fund’s adequate spending and preservation. 

These policies intend to streamline the consistency and sustainability of cash flows. Making a large number of investments or spending huge amounts of money in a year can impact the future operating budget negatively.

Besides, withdrawing these funds continuously can have a consequence on the future purchasing power of funds. Private schools should have an investment committee to assess and review the spending and preservation policy. 

3. Follow the Due Diligence Process

Private schools with an ample supply of endowment funds include various alternative investments like hedge funds, funds of funds, private equity, commodities, and venture capital. All these investments are a part of their asset allocation strategy to manage their portfolio well. 

However, a few of these investment funds do not provide transparency regarding their financial activities and underlying assets. Others have foreign domiciles that bring potential risks that need to be charged.

Following a perfectly implemented due diligence process will streamline the whole management and monitoring system. It will outline the steps that need to be taken to manage, monitor, and implement the funds with [proper taxation and foreign reporting considerations. 

Private School Endowment Funds: 4 Effective Management Tips

4. Allocating Resources Appropriately

Effective management of endowment funds doesn’t necessarily mean implementing a strategic investment plan.

To enhance the endowment’s growth and proper management, it is imperative to foster a good relationship with the families of current students alumni, and other prospective donors. 

A proper advancement team should be there to follow the protocols as it will help in effectively managing these funds. To manage the endowed funds tactically, you can use a spreadsheet filled appropriately to better track records.

Maintaining these records with proper due diligence to avoid errors as incorrect balances and accounting issues can harm donor relationships. 

What is the purpose of private school endowment funds?

Private school endowment funds serve a crucial purpose in ensuring the long-term financial stability and viability of the school. They act as a buffer against economic fluctuations and a source of funding for various initiatives and goals.

Here are some key purposes of these endowment funds:

  • Generate income: The funds are invested, and the generated income (interest, dividends) is used to support the school’s operations. This income can help offset tuition fees, making education more affordable for students and reducing reliance on fundraising.
  • Weather financial storms: Endowments provide a safety net during periods of economic downturn or unexpected financial challenges. The income generated can help the school maintain its quality of education and essential programs even if tuition revenue declines.
  • Long-term planning: The principal amount of the endowment is typically kept intact and invested for the long term. This ensures that the school has a permanent source of funding for future generations of students and faculty.
  • Financial aid: Endowments can be used to fund scholarships and financial aid programs, making the school more accessible to students from diverse backgrounds regardless of their financial situation.
  • Academic innovation: The income can be used to support innovative teaching methods, research initiatives, and expansion of academic programs, thereby enhancing the educational experience for students.
  • Infrastructure and facilities: Endowment funds can also be used to invest in the school’s physical infrastructure, such as renovating buildings, upgrading technology, or building new facilities. This enhances the learning environment and attracts talented faculty and students.
  • Attracting donations: Strong endowments can make a school more attractive to potential donors, as it demonstrates financial stability and a commitment to long-term success.
  • Donor recognition: Donors who contribute to the endowment may receive recognition for their generosity, which can be a motivating factor for philanthropic giving.
  • Legacy building: Contributing to an endowment can be a way for individuals to leave a lasting legacy and ensure the continued success of the school for generations to come.

Endowment funds provide private schools with enhanced flexibility in delivering value and quality of education. The protection and appropriate management of these funds is the duty of the school authorities.

For successful management and potential growth in the future, schools should implement these best practices.

Conclusion

Overall, private school endowment funds play a crucial role in securing the financial future of these institutions and enabling them to provide a high-quality education for their students.

They provide financial stability, support important initiatives, and offer opportunities for donor recognition and legacy building.