How Swarthmore invests: a response to Peter Collings

I write in response to Peter Collings’ open letter, “The Inequity of Swarthmore’s Endowment Spending.” I am often called on to explain why we are not spending more freely from the endowment.

For many of the nation’s most prestigious colleges and universities, endowment totals appear astoundingly high. At Swarthmore College, the endowment stood at $1.6 billion at the June 30, 2013 fiscal year-end. On a per-student basis, ours is one of the largest endowments in the country, and income generated by it allows us to spend on each of our 1,534 students well more than what tuition alone would cover. The endowment is not sitting idle.  It is helping provide a broad curriculum with a low student/faculty ratio and over $30 million in need-based scholarships to the over one-half of our students qualifying for financial aid. The 2014-15 budget recently adopted by the Board of Managers calls for $67.6 million in endowment spending.

In explaining our endowment spending rate, I often use the analogy of a person’s retirement fund. If you were retired and knew you had one year to live, you could spend 100 percent of that fund. If you knew you had four years, you could spend 25 percent each year (ignoring interest and gains); if eight years, 12.5 percent, and so on. For a typical retiree with an average life expectancy, most financial planners would recommend a spending rate in the neighborhood of around 3 to 5 percent, depending on the investment profile and life expectancy.

That, in fact, is quite similar to the rate at which Swarthmore and most peer schools draw from their endowments. Swarthmore’s spending target is 3.5 to 5 percent each year, reflecting that an endowment, which is designed to last in perpetuity, should in theory be spent at a rate near that of the hypothetical retiree.

How do we arrive at that 3.5 to 5 percent rate? We look first at the long-term investment return on an endowment. Most endowment managers in higher education have traditionally expected an average annual return of 5 to 6 percent plus inflation. In the current investment environment, many institutions are lowering these expectations, but let’s just stay with the annual return assumption of 5 to 6 percent plus inflation for now.

The next step is to divide that return to balance it between, first, what can be spent in the present on the educational program and financial aid, and second, what needs to be reinvested in the endowment to keep it growing with inflation and thus to ensure stable spending in future years. In calculating the latter, one approach is to use the consumer price index. If inflation is reinvested, then that leaves the remaining 5 to 6 percent real return that can be spent. Some institutions reach their target spending rates using this logic. Others, including Swarthmore, would argue, however, that the inflation rate for colleges and universities is higher than the CPI because, in part, costs in higher education are heavily salary-driven. Swarthmore’s faculty and staff salaries must stay competitive. Over the past 25 years, the average compensation of a Swarthmore faculty member increased 1.1 percent faster than inflation per year, and scholarships increased almost 3 percent per year faster than inflation. Over that same period, in addition to meeting these pressures and other more normal inflationary increases for many items, the budget also had to expand to add new programs and meet new requirements.

Swarthmore’s endowment spending methodology thus reasonably assumes that Swarthmore’s inflation will be higher than the CPI measure of inflation. That means that 1 to 1.5 percent of the expected real return of 5 to 6 percent needs to be reinvested in the endowment to allow endowment spending in future years to grow at the rate of Swarthmore’s expected inflation. That leaves 3.5 to 5 percent for spending, Swarthmore’s target spending range.

But what about gifts to the endowment? Many institutions justify higher endowment spending rates by including expected gifts in their calculations and treating them like additional returns. Swarthmore does not do this for two reasons. First, alumni, parents and friends are more enthused typically about making a gift to the endowment if it is going to be used to finance a new scholarship, professorship or program rather than to simply balance the budget. (Some of the growth in the College’s scholarship budget, but not all, was indeed covered through new endowed scholarships.) And secondly, Swarthmore’s fundraising is more challenging because a higher percentage of our alumni have chosen careers in the non-profit sector, which can affect their capacity to give. Among its peers, Swarthmore has one of the lowest levels of fundraising.

The Board of Managers, through the Finance Committee, is always observing actual experience and adjusting endowment spending accordingly. During past bull markets, for example, the endowment achieved real returns much higher than expected, and several times there were “step-ups” in spending to make significant program enhancements and address some unmet needs. In contrast, the severity of the 2008 recession and downturn in the endowment caused the College to reduce endowment spending (i.e. a “step-down”) for the first time in more than three decades. Most recently, the 2014-15 budget includes a “step-up” of $2.1 million to restore facilities capital spending to its pre-downturn levels. These adjustments are infrequent, but the purpose of a target spending range is to signal when they should be considered.

In summary, the College’s spending rates are lower than many other institutions for several reasons. A lower spending rate enables higher annual growth in spending in future years to better track the growth of our costs and financial aid. The College’s budget is thus more sustainable into the future. This discipline in the past has served the current generation well and maintains intergenerational equity for the future. Additionally, investment professionals are skeptical that historical rates of investment returns for endowments will be achievable in the current investment environment. As a result, many institutions are trying to reduce their spending rates and will be facing difficult budget decisions. The Board of Managers continuously evaluates the appropriate level of endowment spending. While the College can always decide to spend more in a given year, the key questions are whether it would be sustainable into the future, what additional financial and budget risk would the College be taking, and what are the implications for future generations.

Suzanne P. Welsh is Swarthmore’s Vice President for finance and treasurer.


  1. It sounds like there are a lot of good reasons why a college would be conservative in its spending with its endowment — the cost of inflation on educational institutions is higher — so say many public schools, that makes sense — the market has been bad since the recession, that makes sense (although, maybe not last year? I mean, not to disagree, but it is ironic – you have to admit – that this is the first google result for “college endowment 2013”: It seems like the Board of Managers does a very good job keeping the endowment safe for future generations. I totally appreciate this.
    Yet, maybe this is part of the problem. Maybe the board’s risk aversion could lead to intergenerational inequity, as Professor Collings pointed out.
    [[To make another case in point example of intergenerational inequity: The college is currently planning a multi-million dollar expansion, while a student I know is not back this semester because s/he did not receive adequate financial aid to cover an adjustment in his/her family’s finances.
    As a ‘lay’ student, I have no idea what percentage of the endowment above usual spending (if any!) is going to the college’s planned expansion.]]

    It seems to me that the way our college was differentiated from the similar institutions that Professor Collings pointed out in this op-ed is that we don’t count gifts from donors as part of our projections.
    This makes sense. However, what it leaves one wondering is if this is actually at all different – I mean for students. Obviously there’s a difference for donors — instead of being asked to cover a certain amount of endowment spending every year, they are asked to give generously, and thereby help the college out!
    However for students, the two methods are effectively equivalent, except in q. money spent. Here’s how (I think):
    If Swat’s average spending goal is 4% as Professor Collings writes, then the extra 1% of spending that would bring us to the level of other schools should be found in money from donors. So, effectively, every year we receive 4%(endowment) + whatever donors give (which equals y% of endowment) in spending, whereas students at comparable schools that spend 5% receive a guaranteed 5% (even if the donors don’t contribute it – the endowment takes a ‘hit’). If y<1% of the endowment, then there we have it — spending asymmetry between us and other colleges, and, one could argue, comparative intergenerational asymmetry/inequity.

    Maybe the board could devote 5-(4+y) percent of the endowment to financial aid, and then my friend could come back. I'm sure a million or two could help him/her out.

  2. Tho I’ve burned enough trees to require carbon credits, I seem to recall Swarthmore econ professors teaching me that the most equitable pricing scheme is achieved through perfect price discrimination. True equity would require all to pay what they can pay with no cap on maximum tuition. Perhaps in such a system we would not have to rely on grants and loans for lower income students. I’d be interested to hear from a professor why such a scheme is not in place

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