What is the income yield spending approach and why has it fallen out of favor?

Question

AcadiFi · Accepted Answer

The income yield spending approach limits spending to dividends received plus interest earned, preserving principal and realized/unrealized gains. It was the dominant endowment approach from the 19th century through roughly the 1970s, when UPIA (1972) and later UPMIFA (2006) liberalized spending rules.

The approach has three important limitations. First, it creates a bias toward high-yielding assets — dividend stocks, corporate bonds, preferred shares — at the expense of total return. A growth-oriented technology equity portfolio might earn 12% total return with only 1% dividend yield, while a utility portfolio earns 7% total return with 4% yield. Under income-only spending, the endowment is pushed toward the utilities even though total wealth compounds more slowly.

Second, spending volatility can be severe. Dividend cuts in crises (2008-2009 saw financial-sector dividend cuts above 50%) force immediate program cuts at precisely the moment program needs may be rising. Third, it does not protect real purchasing power. If yields fall structurally, as they did in the 2010s when 10Y Treasury yields averaged below 2.5%, spending-in-real-terms declines even as total returns remain strong.

For a hypothetical 200-member parish endowment of $4M still using income-only spending, the implicit cost of this approach versus a 4% total return rule might be 50 to 100 bps of forgone real return annually, compounding to meaningful understatement over 20 years.

CFA exam: know the historical reason income-yield dominated (state trust law treated principal invasion as impermissible) and that UPMIFA now makes total return the standard.

What is the income yield spending approach and why has it fallen out of favor?

Master Level III with our CFA Course

Related Questions

Practice Questions