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An endowment is a financial vehicle that non-profit organizations use to accept and hold donations from charitable contributors, before they can distribute funding to favored causes.

The endowment is also the sum total of the money held in an endowment fund. That cash is steered toward causes and programs that the organization favors, and that mirror the outlook held by donors to the organization. A reasonable amount of the endowment's funds can be used for operational and business purposes, as predetermined by the endowment's board of directors.

By design, an endowment should only use the interest earned on an endowment fund. The endowment fund's principal amount shouldn't be used for spending purposes - it's meant to remain intact to stabilize the endowment going forward.

Endowments can be created by any non-profit organization, but they are especially common with trusts, charities, foundations, and with colleges and universities. Museums, churches and synagogues and hospitals are particularly likely to use endowments to raise money.

Investment-wise, endowments aren't too aggressive about earning a big return on investment from the principal amount invested on behalf of the endowment. Typically, endowment investment managers aim for a 5% return on an annual basis, relying mostly on conservative investments like bonds and stable stocks and funds.

It's worth noting that endowments are famously private about what investments they rely on to grow their endowment fund. Typically, only the endowment trustees and the fund's investment managers know exactly what type of investments are tied into the endowment.

With endowments, the goal always is to expand the principal amount in the fund through careful investments and to generate enough investment income to fund the causes, projects and operations near and dear to the hearts of endowment managers and their donors.

Why Endowments Are Needed

Historically, endowments still in place today date all the way back to King Henry VIII - yes, that King Henry - when his family created an endowment in divinity studies at England's two most prominent universities - Cambridge and Oxford.

The very first endowment came from ancient Greece, when Marcus Aurelius created the first-ever endowment, for philosophy studies in the Greek capital of Athens.

Not much has changed from a structural point of view over the centuries.

Non-profits still use endowments as the funds necessary to not only run the organization, and to provide the funding needed the fulfill the organization's purpose. For example, that purpose could be to build a new hospital, provide scholarships for inner-city children, or to open new museum exhibits, among other common non-profit needs.

In that light, the most significant benefit from an endowment is that it provides a source of much-needed capital for business and philanthropic needs over a long period of time. Non-profits can use an endowment to fund pet causes and keep the lights on at the same time.

For donors, endowments are an easy charitable fund to give - they can do so with the help of an accountant or estate planning professional and benefit from planned giving on a tax-advantaged basis. At the same time donors are able to fund organizations and charities they are passionate about, and want to keep funding long after they're gone. Endowments make that scenario easier to manage.

Think of an affluent donor who wants to give $10,000 to a favored museum, so it can create better exhibits and hire strong managers, among other needs.

That donor can earmark $1 million of their assets to the museum, via its endowment, for one hundred years, at $10,000 annually. That not only gives donors an easy and effective way to give, it also provides a sense of immortality to the donor. That's a great selling point when a non-profit is trying to attract wealthy donors.

How an Endowment Is Structured

Endowments are akin to corporations in spirit, with a board of trustees, finance committees and a management hierarchy that would be familiar to any company chief executive officer.

Here's how endowments are broken down:

  • A Board of Trustees. Every endowment has a board of trustees, which has the final word on any big decisions
  • An Investment Committee. An endowment's investment committee formulates an investment blueprint for endowment decision makers to follow.
  • An Investment Manager. Endowments also have an investment officer, appointed by the investment committee and approved by the board of directors.
  • Endowment fund managers. An endowment has an investment fund manager, well-schooled in the ways of Wall Street, which chooses the endowment's investments, track portfolio performance, and manage the endowment's finances.

Types of Endowments

Breaking down the issue further, endowments also come in specific models - each designed to maximize the effectiveness of the endowment in question. Here's a closer look at each endowment type:

  • An unrestricted endowment. This form of endowment enables the recipient organization to send an endowment's proceeds as it sees fit - there are no restrictions, as the name indicates.
  • Restricted endowments. With this endowment model, funds (i.e., the principal) are held in the endowment in perpetuity, and the endowment interest is used to further the organization's cause, via instructions by donors.
  • Term endowment. This endowment model limits the spending of endowment assets by a specific period of time or after a specific event is held.
  • A quasi-endowment. A quasi-endowment includes funds directed into an endowment by an individual or group donator, and are intended to have a specific purpose.

There's also a byproduct of endowments - known as endowment invasion - that allows a non-profit group to use donor money to pay bills or to handle operating expenses without direct donor approval. Non-profit groups, after all, aren't much use if they're not solvent and can't pay their bills.

That's where endowment invasion can come in handy, although it may require state government and/or legal approval depending on where the non-profit is located.

Steps to Take Before Creating an Endowment

Non-profits would do well to tread cautiously before creating an endowment. Before stepping into the arena, consider these issues and impactors.

1. Have a Plan

A good endowment should transmit a message to the non-profit community of donors that it's thinking long-term and wants to create a reliable funding vehicle to accomplish not only its mission, but the donors' mission, too (in fact, both need to be compatible for an endowment to succeed.)

2. Focus on Smart Investments

Once the donor money begins rolling in, special attention must be given to the investment of that donor cash. After all, the effectiveness of the endowment depends on the success of the non-profit's investment strategy. Hiring an experienced investment specialist with a record of success, and having a strong board of directors who understand how the investment world works and who can strongly monitor the endowment's investment portfolio isn't a luxury - it's a necessity.

3. Ask the Right Questions

Non-profits need to ask - and answer - some key questions about their endowments before going forward. For example, does the organization require immediate funding needs? Or, is there a priority for growing assets gradually, with the long view in mind? Also, it helps to know how much it will cost the non-profit to manage endowment by itself, or through a professional portfolio management team. A good board of directors will have the right answers to those questions before rolling out the endowment.

Endowments: Growing in Size, Stature

Across the U.S., endowments are on the rise.

According to 2018 data from the U.S. Department of Education, National Center for Education Statistics, endowments at the nation's colleges and universities alone stands at $547 billion, and is growing at a 3% clip per year, asset-wise.

That figure doesn't include the endowment assets tied to hospitals, museums, foundations, and other non-profits, which adds hundreds of billions of dollars to total endowment funds across the U.S.

In that regard, endowments are in a robust period of growth right now, and with the baby boomers entering their senior years with legacies in mind, expect endowments to grow even more prevalent (and more financially secure) in the years ahead.

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