Endowments vs. Investments: Investing in the Future of Nonprofits
Financial stability is paramount for all nonprofit organizations, as it allows them to effectively fulfill their missions. For long term sustainability, nonprofits should look to diversify their funding sources and have effective financial management practices in place. Some of those funding sources may include the use of endowments and investments. While endowments and investments both involve the use of funds to generate financial returns, there are significant differences to each. This article will explore the differences between endowments and investments, as well as look at common challenges faced managing those assets.
Endowments
Endowments are a type of investment that is utilized to build long-term financial stability. They are typically donated funds or financial assets that are invested by institutions. They generate income for nonprofit organizations through investment earnings, while the principal (called corpus) is kept intact. Additionally, these types of investments have specific restrictions on spending or use of funds set by the donors or through designations by the organization’s board of directors. According to Corporate Finance Institute, endowments can be broken up into four categories based on their restriction type:
- Term/Expendable Endowment: Term endowments are when the principal of the endowment may be spent only after a specific period of time or an event has occurred. Expendable endowments are purpose driven, where corpus can be spent as specified in the fund’s terms.
- Restricted Endowment: These funds are restricted for a particular purpose set by the donor. For example, an endowment fund donated to a university may only be used to pay scholarships or other academic support.
- Unrestricted Endowment: Contrasting a restricted endowment, the funds generated from returns can be used for any purpose the organization wishes.
- Quasi Endowment: These funds are not required by any legal restriction to exist permanently. These funds are commonly known as board designated endowments. There is more flexibility within a quasi-endowment, as the board has the ability to end the restriction for any reason. These endowments differ slightly from term/expendable based on restriction. These are typically classified as permanent endowments as corpus is maintained.
Spending Policy
Another key element differentiating endowments from investments is the spending policy. For most states, they are governed by the Uniform Prudent Management of Institutional Funds Act (UPMIFA). The UPMIFA replaced the old standard of Uniform Management of Institutional Funds Act (UMIFA). The change in spending under the UPMIFA removed the historic dollar value (HDV) limitation on spending institutional funds. Meaning, if the fair market value of the fund falls below the initial HDV of the original donation, nonprofits would now be permitted to spend as much of the endowed funds as they deem prudent. There are seven factors to consider under the UPMIFA when constructing a spending policy. They are as followed:
- Duration of the endowment fund
- Purpose of the institution and its endowed funds
- General economic conditions
- Potential effects of inflation or deflation
- Expected total return of endowment
- Organizational resources
- Organizational investment policy
Pennsylvania is the only state that has not adopted UPMIFA in some form. Pennsylvania is governed by Act 141 which allows organizations to adopt a total return investment policy. This means organizations can spend a percentage of the endowment’s total market value which includes income and capital gains. Typically, boards will assess the spending percentage annually between 2%-7% as required by Act 141.
Investments
A way to describe the relationship between endowments and investments is all endowments are investments, but not all investments are endowments. Standard investments are funds used for personal, institutional, or corporate purposes to generate returns or appreciate over time. Similarly, this can be done by investing the asset into stocks, bonds, mutual funds, etc. The goal of investments is to increase earnings through dividends, interest, or capital gains. Typically, the original principal amount can be accessed if necessary, and these funds may or may not have restricted usage.
Investments can help further a nonprofit’s mission through the following:
- Working Capital Fund: A working capital fund can be used for short term expenses, like payroll or unexpected bills. It can also be used to manage payments between grant payments and grant expenditures.
- Operating Reserves: Like a working capital fund, investments can help fund operating reserves for nonprofits. These funds are set aside “for a rainy day” and can be utilized for longer term expenses.
Investments do carry a certain amount of risk. It is important for the board of directors to adopt an investment policy based their organization’s risk tolerance. Proper oversight can ensure financial success through the use of investments.
Key Differences
| Feature | Endowments | Investments |
| Purpose | Supports organizations mission long term | Builds wealth and generates return. Can be used to generate reserves |
| Liquidity | Illiquid/long-term | Can be short term or long term |
| Restrictions | Usually donor restricted /board designated | Typically, unrestricted |
Challenges of Nonprofit Investing
No matter which type of investment strategy is used, it is important to remember that nonprofit investing is quite different than individual investing. Management over endowments and investment funds can require financial expertise, legal oversight, and transparent governance structure. Establishing a well-designed investment policy can allow the organization to maximize returns while still upholding the organizations long-term mission. For additional information regarding nonprofit investing and its challenges, watch our webinar, “Investing for Success as a Nonprofit Organization.”
If you have questions about the information outlined above, please reach out to a member of our Nonprofit team. You can also learn more about our nonprofit services by visiting our Nonprofit industry page.
About the Author
Mara joined McKonly & Asbury in 2021 and is currently a Senior Accountant with the firm. She is a member of the firm’s Assurance & Advisory Segment, servicing clients in affordable housing and nonprofit segments.
