A spending policy consists of a systematic approach that enables foundations and endowments to calculate their targeted distributions. In addition, a spending policy can have significant implications for a fund's long-term investment policy. A spending policy is not a distinct issue. 

There are many viable approaches to establishing a spending policy. From an investment standpoint, virtually all of these approaches are legitimate, as long as they are based on some aspect of a fund's total return, and are not tied to the amount of income, i.e., interest and dividends, that the fund produces. A downward trend in dividend yields, the volatility of interest rates and the lower historical returns of fixed income securities all argue against any type of income oriented approach. 

While IPEX can help a client to adopt virtually any type of spending policy, there are certain policies that we recommend. Over the long-term, we believe that the amount of money distributed from a fund should be related to the fund's market value. To ignore market value is to ignore reality. Specifically, the distribution target should be stated as a percentage of the market value. There are variations of this approach that allow clients to fine-tune a spending policy to best match their objectives. 

Regardless of the spending policies that they have implemented, endowments and foundations should never lose sight of the fact that their spending target, return objective and risk profile, as well as their fund's asset allocation, remain inextricably linked. The higher their spending target, the higher their return objective will need to be, assuming that they want to maintain the same growth rate, net of inflation. The higher their return objective, in turn, the more their fund will need to adopt an asset allocation geared toward asset classes that have demonstrated higher historical returns, but that are also more volatile. At some point, this increased volatility may conflict with their risk profile. The process of developing a spending policy requires balancing all four of these factors. 

Those endowments and foundations seeking to increase their real rate of distributions need to set a return objective above the sum of their distribution target and the projected inflation rate. This objective can be met by adopting a more aggressive asset mix or by decreasing the current spending target. Regardless of the type of spending policy, there remains an inherent tension between current distributions and long-term growth.