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Web Exclusives: More February 21, 2001: (January 2001) Objective The primary objective of Princeton's endowment spending policy is to achieve a proper balance between present and future needs of the University. Other objectives are to achieve a reasonable degree of stability and predictability in income available for current operations and to insulate the University's investment managers from any pressure to produce short-term gains as opposed to achieving the best total return over the longer term. Princeton's Policy: A spending Rule Princeton adopted its current policy in 1979. It is based on a spending rule. The rule says that the amount of spending per unit of endowment will increase each year by a stipulated percentage. (The endowment can be thought of as a mutual fund in which each endowed program owns a certain number of units.) Currently the annual increase is 5% per year. This means that regardless of a year's market performance or how much of a year's earnings take the form of dividends, interest, or capital appreciation, the amount of spending per unit of endowment each year will be 5% more than the previous year. (The total amount of endowment spending also is affected by new gifts, which create new units of endowment.) The Spending Rate Applying this rule results, each year, in a spending rate, defined as the amount of endowment spending divided by the overall endowment value. While Princeton's policy does not establish an explicit spending rate -- it results from the application of the spending rule and fluctuations over time in the value of the endowment -- the University has long thought that a spending rate between 4% and 5% of the market value of the endowment was desirable and appropriate. Relationship Between "Rule" and "Rate" The spending rule is based on two key assumptions: (1) that the University's inflation rate over time will likely average about 5% and (2) that the total return on the University's endowment over time will likely average between 9% and 10%. If total return averages between 9% and 10% and endowment spending increases each year by 5% (as the "rule" stipulates), the spending "rate" would be between 4% and 5%. In this idealized world, the University would be earning between 9% and 10% on its endowment; it would be spending between 4% and 5% of the value of its endowment each year on current operations; and it would be reinvesting 5% each year to pay for the next year's increase in spending and thereby preserve the purchasing power of the endowment into the future. Periodic Adjustments Although the only number in this equation established by policy (the spending rule) is the 5% annual increase in spending per unit of endowment, the trustees periodically have reviewed the actual spending rate to see whether it is falling in the range of 4%-5%. Since the current rule was adopted in 1979, the trustees have made several upward adjustments in spending after higher-than-expected total returns on the endowment pushed the spending rate below that range. While the rate changes daily as the value of the endowment fluctuates, the recent spending rate has been in the range of 3-3.5%. Calculating the Rate In calculating its spending rate (endowment spending divided by endowment value), the University includes only its primary investment pool (currently over $6 billion). This excludes the separately invested Robertson Foundation funds that support the graduate program of the Woodrow Wilson School, funds invested for the short-term (for example, funds waiting to be spent on major construction projects), and a variety of other very restricted or special purpose investments (such as loans to parents, faculty or staff). Previous Adjustments This year's adjustment is the sixth since the current policy was adopted in 1979. In 1982, the annual percentage increase was changed from its original 6% to 8%. In 1986, the annual percentage increase was reduced to 7%, but an upward adjustment was made in the amount of spending to increase the spending rate to roughly 4.5%. (Because of superior investment performance, it had fallen below 3.5%.) Any increase in spending affects both restricted accounts (such as library acquisitions and certain academic programs) and funds for discretionary allocation. (This year's $57 million increase in spending provides an additional $16 million to restricted accounts and $41 million for discretionary allocation.) The discretionary portions of the three adjustments in the 1990s were all targeted toward recurring capital needs: 1991: The annual percentage increase was reduced to 6% while spending available for discretionary allocation was adjusted upward by approximately $9 million. These funds were used to pay for classroom renovations and modifications necessary to meet code requirements, laboratory renovations and the installation of improved utility systems. 1996: The annual percentage increase was reduced to 5.5% while centrally allocated spending was adjusted upward by approximately $6 million. These funds were used to create a new renovation fund to augment the University's regular major maintenance program, with a particular emphasis on dormitory renovations. 1999: The annual percentage increase was reduced to its current level of 5% while centrally allocated spending was adjusted upward by approximately $14 million. $11 million were used immediately for major maintenance and renovation, to help move toward a goal of budgeting 2% of the replacement value of the physical plant each year for these purposes. The remaining $3 million were designated for eventual use for these purposes, but were available in the interim to help meet the phase-in costs of new financial aid policies adopted the previous year and the operating costs of several new facilities, including the Frist Campus Center, as they came on line. 2001: This year's adjustment leaves the annual percentage increase at 5% but increases centrally allocated spending by approximately $41 million, which will be used to provide increased support for graduate education, undergraduate financial aid, new educational initiatives and building construction and renovation.
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