What Is an Endowment? - Definition & Effect

Instructor: Michael Cozad

Michael is a financial planner and has a master's degree in financial services.

This lesson will provide an overview of an endowment. Financial endowments affect numerous recipients, and those effects will be explored in this lesson.

Overview

Perhaps you've read or heard about colleges and universities having or receiving endowments. For example, just by typing 'Harvard Endowment' into my Google search bar and pressing enter, a box appears on my screen saying '$32 billion,' and 'largest endowment in the country.'

That's a pretty phenomenal amount of money, isn't it? But if you're unfamiliar with the term 'endowment', you are probably left wondering why Harvard has that much money and what they're going to do with it.

Definition

All right, we're moving on to the definition. An endowment is, at its most basic level, a financial donation set aside to meet a stated goal of the donor.

Meet Richie Rex Rich. 'R-Cubed', as his friends call him, graduated from Harvard with his undergraduate degree in 1965, his master's degree in 1967, and doctorate in 1971. His wife, known to R-Cubed as 'The Duchess,' graduated with Richie with the same degrees - joint business and medical degrees. They are in business together in Cambridge, just down the road from Harvard. Needless to say, the Rich's are lifelong supporters of Harvard and its business and medical schools.

Giving

The Rich's parents died last year and the inheritance was about $500,000. Add in the $500,000 the Rich's have saved, and they want to donate $1,000,000 to Harvard for the purpose of allowing future joint business and medical students to receive scholarships.

The Rich's meet with an officer from Harvard, where they discuss their intent to donate the $1 million. Harvard draws a contract, and soon thereafter, the Rich's send a check to Harvard for $1 million.

The contract the Rich's signed outlines the goals they have for the $1 million. It states that the $1 million will be added to Harvard's general endowment (which will include the Rich's $1 million gift plus gifts of donors all across the world). The contract states that each year, Harvard is allowed to give 5% of the Rich's gift out in the form of scholarships to those who have earned only As in high school and that 10 scholarships will be awarded.

Effect

Based on the initial $1 million gift, Harvard can award 10 $5,000 scholarships. With any hope, there is growth on the remaining $950,000 (which is $1 million minus $50,000 in scholarships), that can be used to fund scholarships indefinitely.

For example, if the $950,000 grows back to $1 million, the 10 scholarships each of $5,000 can continue. If it grows even more, the contract may have stated that it will still continue to give 10 $5,000 scholarships and that the rest can be kept in the endowment. This could keep growing Mr. and Mrs. Rich's gift for future years.

As you can see, just because the Rich's donated $1 million doesn't mean that Harvard spent it all at once. In fact, it is most likely that the intent of Mr. and Mrs. Rich was to have the 10 $5,000 scholarships awarded forever. It was also likely that the $1 million doesn't change a whole lot in value.

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