How does a three-year moving-average smoothing rule stabilize endowment spending?

Q: How does a three-year moving-average smoothing rule stabilize endowment spending?

A three-year moving-average spending rule sets current-year spending as: Spending_t = rate × (MV_{t−1} + MV_{t−2} + MV_{t−3}) / 3. The averaging window smooths year-to-year volatility but introduces lag.\n\nExample: Aldevale Liberal Arts uses a 3-year MA with rate 4.80%. MV history: 2024 end = $520M, 2025 end = $595M, 2026 end = $468M (after 21% market decline).\n\n2027 spending = 4.80% × ($520M + $595M + $468M) / 3 = 4.80% × $527.67M = $25.33M.\n\nCompare to simple method: 4.80% × $468M = $22.46M. The 3-year average pays $2.87M more, buffering the decline.\n\nNow imagine a rebound: MV 2027 end = $580M. 2028 spending = 4.80% × ($595 + $468 + $580)/3 = 4.80% × $547.67M = $26.29M — only modestly higher despite a 24% market rally, because the window still includes depressed 2026.\n\n```mermaid\nflowchart LR\n A[MV 2024 520M] --> D[Average]\n B[MV 2025 595M] --> D\n C[MV 2026 468M] --> D\n D -->|Avg 527.67M| E[x 4.80% rate]\n E --> F[2027 Spending 25.33M]\n```\n\nPros: dampens budget volatility, easier academic planning, reduces pressure for panic liquidation.\nCons: lag creates 'spending overhang' after drawdowns (you're spending from a smaller corpus at rates calibrated to prior wealth), and 'spending undershoot' after rebounds (opportunity cost).\n\nLonger windows (5-7 years) smooth more but lag more. Most universities favor 3-year MA as a compromise. Combined with a Yale-rule hybrid, this becomes quite robust — stability from the prior-spending term, responsiveness from the rate-times-MV term.

Question

AcadiFi · Accepted Answer

A three-year moving-average spending rule smooths volatility but introduces lag that can create spending overhang or undershoot.

Unlock with Scholar — $19/month

Get full access to all Q&A answers, practice question explanations, and progress tracking.

Start 7-Day Free Trial Compare Plans

No credit card required for free trial

Example: Aldevale Liberal Arts uses a 3-year MA with rate 4.80%. MV history: 2024 end = $520M, 2025 end = $595M, 2026 end = $468M (after 21% market decline).

2027 spending = 4.80% × ($520M + $595M + $468M) / 3 = 4.80% × $527.67M = $25.33M.

Compare to simple method: 4.80% × $468M = $22.46M. The 3-year average pays $2.87M more, buffering the decline.

Now imagine a rebound: MV 2027 end = $580M. 2028 spending = 4.80% × ($595 + $468 + $580)/3 = 4.80% × $547.67M = $26.29M — only modestly higher despite a 24% market rally, because the window still includes depressed 2026.

```mermaid
flowchart LR
  A[MV 2024 520M] --> D[Average]
  B[MV 2025 595M] --> D
  C[MV 2026 468M] --> D
  D -->|Avg 527.67M| E[x 4.80% rate]
  E --> F[2027 Spending 25.33M]
```

Pros: dampens budget volatility, easier academic planning, reduces pressure for panic liquidation.
Cons: lag creates 'spending overhang' after drawdowns (you're spending from a smaller corpus at rates calibrated to prior wealth), and 'spending undershoot' after rebounds (opportunity cost).

Longer windows (5-7 years) smooth more but lag more. Most universities favor 3-year MA as a compromise. Combined with a Yale-rule hybrid, this becomes quite robust — stability from the prior-spending term, responsiveness from the rate-times-MV term.

How does a three-year moving-average smoothing rule stabilize endowment spending?

Master Level III with our CFA Course

Related Questions

Practice Questions