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A Delicate Balance
Norman E. Nabhan, CIMAŽ, Managing Director, Institutional Consulting Director, Graystone Consulting

December, 2014


The rising stock market of the 1990s led some critics of not- for-profit organizations to call for greater spending levels based on gains realized on endowed portfolios. Some critics called for the raise of the annual payout requirement for private foundations from the currently mandated 5% to 6%, 7% or even 8% of assets. Unfortunately, the days of outsized performance results could not be sustained indefinitely and the returns of the decade starting in 2000 have shown, in retrospect, that such spending targets could have posed a formidable challenge for organizations seeking to protect their foundations from serious erosion — or spending into extinction. This paper is intended to help foundations and not- for-profit managers understand the spending and investment choices they face. It describes the components of an effective planning process and explains how effective portfolio management can help trustees and directors prudently manage both their current and future needs — particularly through periods of market volatility.

The Balance Between Spending and Investment Policy

In theory, a successful financial management plan for a foundation or nonprofit organization has one main goal: to maximize the resources available to support the organization’s mission. These charitable endeavors may be targeted at programs such as museums, schools or libraries, grants to other nonprofit groups, scholarships or any number of charitable gifts designed to help individuals, organizations and communities. The charitable planning process requires officials to balance the expected life of the programs to be funded against the desired life of the foundation or organization. This involves the management of two broad trade-offs: between current spending and future spending on the one hand, and between investment risk and return on the other. The law requires that private foundations spend an amount equal to at least 5% of their prior year’s investment assets each year, subject to certain adjustments. Failure to meet this target can result in a tax equal to 15% of the unspent amount. Additional excise taxes (100 percent of undistributed income) are imposed

on any undistributed income of the pertinent taxable year remaining at the close of the correction period. Spending in excess of the minimum can be carried forward and applied to later years, up to a maximum of five years. Many nonprofits receive financial support from a related foundation or from the investment income or gains from their reserve funds. Trustees must understand the impact that spending decisions can have on their investment policies. A high rate of spending may require a relatively aggressive-and-riskier-portfolio strategy to support that spending. Conversely, trustees who prefer a more conservative investment approach may need to reduce spending. The stakes are high: trustees who craft incompatible spending and investment policies may jeopardize the future of their institution and violate their fiduciary duty to manage charitable assets wisely and effectively.

The Role of Spending Policy

Developing an appropriate spending policy is one of the hardest steps in the nonprofit planning process. Only after the spending policy is defined can the fund’s asset allocation policy be determined. If a fund must spend 5% per annum, and inflation is projected to be 2.5%, then a fund must earn at least 8.0% to “break even” on an after-inflation basis. The fund must also account for the impact that investment and administrative expenses have on fund assets. (Figure 1)

To read more please go to 

Norman E. NabhanCIMA®
Managing Director, Wealth Management
Financial Advisor
Institutional Consulting Director 

tel: (713) 499-3024
toll-free: (800) 666-6069 
fax: (713) 499-3090


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