Where’s Tobin? Protecting Intergenerational Equity for Endowments: A New Benchmarking Approach

Abstract

Tobin’s thoughtful admonition that the trustees of an endowed institution should guard the future against the spending needs of the present cannot be perfectly implemented in practice given today’s aggressive investment policies. The authors introduce an understandable toolkit for benchmarking and evaluating any given spending rule so that it protects future spending at some engineered level of probability. They use basic tools of finance—perpetuity math, budget constraints, economic balance sheets, well-supported assumptions for expected return, the discount rate and the growth rate, and multiperiod distribution charts—to assist the institution in achieving its desired probability of maintaining spending power in the long run. The authors address the common practice of smoothing and the problems it creates, and set forth a rule of conservation of risk: Spending risk is set by the risk of the investments used to fund the spending, not by the spending policy itself. Smoothing does not make risk go away; it just hides it for a while, deferring it to a later generation.