Takeaways
- Endowment funds are pools of capital invested on behalf of nonprofits.
- Endowment funds can receive interest income, dividends, and other investment returns.
- Endowment funds support colleges, universities, and cultural organizations.
- Endowment funds come from donations of cash, investments, and property.
- Endowment funds have use restrictions and are generally limited to spending income only from funds and capital appreciation, not principal investments.
What Is an Endowment Fund?
An endowment fund is a pool of investment money that nonprofit organizations, such as universities, charities, or institutions of cultural significance, hold. Endowment funds are made up of endowments or financial gifts from individuals and trusts. The primary purpose of an endowment fund is to create a consistent source of operating income for the organization to support its participants and members over the long term.
Endowment funds consist of donations and investments, with the principal invested to generate investment returns. The investment income earned from these investments supports the organization's operations, programs, or projects.
Donors tend to set the terms of their donations and what those funds can be used for, but most donations are restricted to only using income from investments without touching the principal investment. This approach creates an evergreen source of income for the nonprofit.
Endowment funds are designed to be permanent, with the principal remaining intact. Only investment earnings are used for organizational expenditures. This results in greater financial stability and general sustainability for the organization, facilitating its mission and goals over time.
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How Does an Endowment Work?
An endowment works very similarly to conventional investment approaches, such as pension funds. The fund is created through the generous donations of high-income earners, famous graduates, or those who embrace the cultural cause.
Their donations are the principal investment, which is invested across a diverse mix of asset classes such as stocks, bonds, and real estate properties. The principal is preserved, and only the investment returns are used for funding organizational activities.
An endowment fund is generally managed by financial professionals who strive to balance growth and income generation. The general investment approach is to craft a strategy that provides steady returns while also preserving the fund's value. This usually means high capital allocations to fixed-income investments like dividend-paying stocks, high-yield savings accounts, corporate bonds, and U.S. Treasury bills.
Although there is significant interest in producing income, some funds are allocated to generate more investment returns. There is a heavy emphasis on diversification and an appetite for low investment risk tolerance. Fund managers try to keep their income stream relatively consistent, which allows the nonprofits to operate smoothly.
Each nonprofit organization has specific policies that determine how the endowment fund will be used. The organization can benefit from long-term financial sustenance throughout bull markets and bear markets through careful management of the endowment's principal.
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3 Policies of Endowments
Just like with C Corporations, which have investment policies, endowments typically have three policies that govern how they use donations. Here are the three standard policies:
Investment Policy
The investment policy of an endowment fund outlines how the fund's assets are allocated to generate returns and manage risk.
This policy will include guidelines for diversified portfolios across various asset classes, sometimes with specific allocations or percentages of the fund. The primary goal, of course, is capital preservation and finding a balance between growth and income. Donors want the endowment fund to be self-sustaining.
Withdrawal Policy
The withdrawal policy regulates the specifics of accessing the funds from the endowment. This policy safeguards against withdrawals that could compromise the endowment's long-term viability
The withdrawal is typically limited to a percentage of the fund’s average value over several years.
Usage Policy
An endowment's usage policy defines what the funds can be spent on. The policy ensures the funds are used in alignment with the donor's intentions and the organization's mission. The usage policy acts as a guiding document for nonprofits.
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4 Types of Endowments
There are many different types of endowments; here are four main categories of endowments:
1. Unrestricted Endowments
Unrestricted endowments let the organization disburse and use the funds however it sees fit. This endowment provides the most flexibility, enabling the organization to allocate funds to the most urgent or strategic priorities. Unrestricted endowments can be dynamic and respond quickly to changing situations.
2. Term Endowments
Term endowments are donations in which the principal cannot be accessed until a specific period, at which point the principal is either returned to the donor or transferred to another fund. During the endowment's term, the organization can use the income to support its projects and programs as it sees fit.
3. Quasi Endowments
Quasi-endowments, or board-designated endowments, are crafted by an organization’s board from its general funds. This means that the nonprofit organization itself sets up the fund.[1]
While the principal cannot be touched in traditional endowments, it can be accessed if needed in a quasi-endowment. Access to this capital can give the organization more flexibility in times of need.
4. Restricted Endowments
Restricted endowments are bound by specific provisions the donor creates, which dictate how funds will be used. These investment restrictions can include supporting particular programs or using the funds only for research. The organization must adhere to these conditions when using the endowment's income.
Endowments for Higher Education
Endowments for higher education, such as colleges and universities, are a foundational element of supporting those institutions. Endowment funds typically come from donations and are used to finance scholarships, faculty positions, research, equipment, and even new campus facilities.
Endowment funds help institutions of higher learning to attract and retain top academic talent, improve student experiences, and maintain financial stability. Many colleges and universities have substantial endowments, critical elements of their long-term economic health.
Top 5 University Endowments
Here are the top five endowments by market value as of the end of 2023:[2]
- Havard University at $49.5 Billion
- The University of Texas System at $45.0 Billion
- Yale University at $40.7 Billion
- Stanford University at $36.5 Billion
- Princeton University at $34.1 Billion
Smart Summary
Endowment funds are pools of money made up of endowments or donations. These donations range from cash, stock, real estate, and other gifts. The endowment's investment capital is used to generate investment income to support nonprofit organizations. Investment strategies tend to be conservative, focusing on fixed-income strategies and capital preservation. Evergreen income sources allow nonprofits to operate perpetually and support donors' long-term wishes.
(1) San Diego Foundation. What is an endowment fund. Last Accessed January 14, 2025.
(2) University Business. The top 20 university endowments of 2023. Last Accessed January 14, 2025.
