Total Income or Total Return Investing for Church Endowments

There are two major philosophies when it comes to how funds should be invested for the long-term benefit of the organizations holding the assets.

The Total Return Method

  • Modern portfolio management states that a return of 8% per year is something that should be expected.
  • Return is defined as total appreciation of the investment portfolio: this includes realized and unrealized gains/losses, interest, income, and dividends
  • US inflation has averaged 3% per year since 1928
  • A fund should always “plow back” at least 3% of its total appreciation per year into the total investment portfolio
  • That leaves, on average, 5% of the total appreciation which can and should be expended each year for the benefit of the organization for which the portfolio was created
  • The legal courts have ruled that foundations and endowments should spend 4-6% per year of their total investment portfolio on the purposes for which the donors gave the money
  • Distributing 4-6% and retaining 3% means the investment portfolio will always have the original purchasing power at the time of the gift
  • It also means that the investment portfolio will be invested in ways to achieve maximum

 The Total Income Method

  • For several hundred years, investment managers invested solely in income-producing financial instruments
  • Each year, the organizations “harvested” all or most of the investment income
  • Investing for total income results in a very different financial portfolio than investing for total growth
  • Inflation was not taken into consideration when investing for income
  • Over time, the portfolios invested in income-producing financial instruments were eroded by inflation and the organization used up the corpus to maintain its operations

Today, no major foundation or endowment uses Total Income; all have switched to Total Return. And, all use a 12 (or 16 or rarely a 20) quarter trailing average. That means they look at the past twelve quarters (3 years) and take the average of those quarters and then multiply that average by the 4-6% to be distributed. Looking back over 3, 4, or even 5 years flattens out many roller coaster curves of investments. Most foundation board decide each year what the distribution rate will be but it is almost always between 4 and 6% (e.g., sometimes 4.5%, sometimes 5.8%, etc.) depending on the financial investment returns for the prior year.

I could go on for about two more hours, but I won’t.

Lead On!