An endowment is a financial asset, donation, or investment fund set up by an individual, institution, or non-profit entity such as a university or a foundation. The primary purpose of an endowment is to allow the endowed funds to grow over the long term and provide a continuous source of income without touching the principal amount or corpus.
Endowments are typically funded by donations and are often arranged so that the principal amount remains intact while the investment income is available for use. This arrangement allows for the donation to have an impact over a longer period of time than if it were spent all at once.
Endowments are frequently used by non-profit organizations, universities, hospitals, and churches. They are often critical for these institutions because they can provide a level of financial stability and fund activities, scholarships, research, or projects that align with the organization’s mission.
The rules of endowments, such as how funds can be used, are often defined by the donor in a formal endowment agreement. Moreover, the invested funds are typically managed by professionals who invest in a diversified portfolio to ensure steady growth and income generation over time.
Example of an Endowment
Let’s say a wealthy alumnus of University XYZ wants to provide ongoing financial support to the university. So, she decides to set up an endowment.
She gifts $5 million to the university with specific instructions that this money is to be used to fund scholarships for deserving students in the field of computer science. However, the university is not to spend the $5 million itself. Instead, it is to invest the money and use only the income generated from these investments to fund the scholarships.
The university then invests this $5 million in a diverse portfolio of stocks, bonds, and other assets. Over the next year, the endowment generates $200,000 in investment income (a 4% return). This $200,000 can then be used to fund scholarships as per the donor’s instructions.
The original $5 million remains invested for future years, continuing to generate investment income that can be used for scholarships year after year. This is a simple example of how an endowment works. It allows the donor’s gift to provide ongoing benefits, rather than being spent all at once.