The Power of Endowments

Every non-profit organization strives to create endowment funds as a part of their finance strategy. But why are they so important and how should newer organizations attempt to create them? Let’s start by defining an endowment, which can be described as a sum of money that is permanently invested in equities (stocks) and fixed income (bonds and CD’s, etc) in order to increase the size of the endowment every year. The organization which owns the endowment spends only a certain percentage of the fund each year but typically would not spend any of the initial principle which is being invested. The spending would typically be from the appreciation from investment gains.

Endowments can be restricted for specific purposes such as programs or collections, or they can be unrestricted so that the money withdrawn from the endowment each year can be spent on anything the organization wishes to support including its own operations. Most organizations would agree that unrestricted endowments are the most valuable ones to have since they allow for the most flexibility. Endowments may be restricted by a donor, or sometimes the Board of Directors of the fundraising organization can designate an endowment as restricted. If a donor restricts the endowment, it cannot typically become unrestricted. However, if the Board restricts an endowment, they can also remove the restriction by Board action.

The reason that most organizations try to raise endowment funds is that they provide stability. If you are writing a grant to a funding source or asking an individual for an annual contribution, there is always a possibility that the person or organization won’t fund your request in year two, three, or beyond. With an endowment, you can be assured that there will be income from that endowment every year in perpetuity. This removes some of the uncertainty of budgeting in an organization dependent on fundraising. It should also be noted that most library organizations have aging donor bases. Once this older generation is no longer around, it may take many years for the much younger generation to get to the point of philanthropic generosity of the older generation. Having endowments in place will help cushion an organization’s transition to this younger and less affluent donor base.

The most typical ways to create endowments are through capital campaigns and planned giving efforts. Many organizations which are raising private funding for a new or renovated building add an endowment component. It makes sense if you are raising private funds for the building to also raise funds for a book and materials endowment or a programming endowment. Most capital campaign gifts are made to the entire scope of projects rather than to just the building. This makes it easier to raise endowment funds than if you were trying to raise private funds just for an endowment.

The other way to create endowments is through having a robust program of planned giving. Asking your donors to consider leaving money in their will or estate plan or asking them to leave a percentage of a retirement plan or life insurance policy to your Friends or Library Foundation is an easy way to begin building endowments. Most organizations have a policy that requires all planned gifts to be placed into an endowment rather than spending it outright. The only exception is when the donor has specifically requested that it be spent immediately.

A final consideration for creating endowments is through a bookplate program. Most libraries have bookplate programs in place where a donor can pay $25 or more and have a bookplate placed in a newly purchased book to honor or memorialize someone else. Instead of using these contributions to buy the new books, you might want to consider saving all of those contributions and placing them into an endowment for books and materials. Each year your organization can take a percentage of that fund to buy books and materials for the library.

Investing the endowment funds is just as important as raising them. Your organization should have a Finance Committee to oversee the decisions of investing and also setting an investment policy stating what types of investments the organization is allowed to have. Community Foundations are one possible place to invest your endowment funds. The advantage of this is to organizations that don’t have Board members with investment expertise. The disadvantage is that you lose control of your funds. The Community Foundation determines how much income you receive each year and when that will happen. Many Community Foundations also have a requirement that once the funds are deposited there, you cannot remove them easily. Banks and investment firms are other possible places to invest these funds.

The other decision you need to make is how much of the endowment will be invested in stocks and how much in fixed income. This is known as your asset allocation. Most organizations believe an asset allocation of 60-70% stocks and 30-40% fixed income is a prudent mix. The most important thing to remember is that if your library itself is a part of city or county government, it is not allowed to invest funds in anything except fixed income. Over the long haul, the returns from this type of investing will be markedly lower than investing in stocks and fixed income. Therefore it is critical that your Friends or Foundation be ready to accept endowment funds or planned gifts before a donor specifies in their will or estate plan that the funds will go to the Library and not to the non-profit organization which supports the library.

Spending policy is the final decision to be made with an endowment. Obviously, the returns on investments will vary dramatically from year to year. In the last decade, investment returns for a balanced portfolio of stocks and fixed income have varied from a high return of almost 20% to a low of a negative 12% in 2008. But the annual returns shouldn’t determine how much you spend. You should spend the same percentage amount each year. This is the stability factor referred to earlier in this article. Most organizations spend between 4 and 5% of the value of their endowment fund each year. This is called your endowment drawdown.

To stabilize your funding even further, most organizations use the average value of their endowment fund over the past 12 or 16 quarters to determine how much to draw down. That way a large loss in one year won’t mean dramatically less drawdown the following year. Similarly, a large increase in one year won’t translate into a huge increase in drawdown the next year but will be averaged into the values of the preceding three of four years. Once again, stability is the goal.

Endowments are not just for universities, orchestras, and museums with tens or hundreds of millions of dollars to invest. An endowment of as little as  $100,000 can be useful for the future stability and growth of your Friends or Library Foundation. The best time to start creating your endowment was thirty years ago. The second best time to create it is now.