What are the main endowment spending rules, and how do they balance stability of spending with capital preservation?

Endowment spending rules determine how much of the portfolio is distributed each year. The fundamental tension is between spending stability (smooth, predictable distributions) and capital preservation (protecting real purchasing power over time). No single rule dominates; each makes a different trade-off.\n\nThe Four Main Rules:\n\n`mermaid\ngraph TD\n A[\"Spending Rules\"] --> B[\"Simple Rate
Spend % of current value\"]\n A --> C[\"Rolling Average
Spend % of N-period avg\"]\n A --> D[\"Geometric Smoothing
Weighted blend of prior + current\"]\n A --> E[\"Hybrid / Yale Rule
Inflation-adjusted + market-based\"]\n B --> F[\"High volatility
Good capital preservation\"]\n C --> G[\"Moderate volatility
Good capital preservation\"]\n D --> H[\"Low volatility
Moderate capital preservation\"]\n E --> I[\"Lowest volatility
Best balance\"]\n`\n\nComparison Using Brightmoor Endowment ($500M, target 5% spend):\n\nAssume the portfolio returns -12% in Year 1, then +18% in Year 2.\n\nRule 1: Simple Spending Rate (5% of current market value)\n- Year 0 spending: 5% x $500M = $25.0M\n- After Year 1: $500M x 0.88 - $25M = $415M. Year 1 spending: 5% x $415M = $20.75M\n- After Year 2: $415M x 1.18 - $20.75M = $468.95M. Year 2 spending: 5% x $468.95M = $23.45M\n- Spending volatility: $25.0M -> $20.75M -> $23.45M (17% drop then 13% recovery)\n\nRule 2: 3-Year Rolling Average\n- Year 1 spending: 5% x average($500M, $500M, $415M) = 5% x $471.7M = $23.58M\n- Year 2 spending: 5% x average($500M, $415M, $468.95M) = 5% x $461.3M = $23.07M\n- Spending volatility: $25.0M -> $23.58M -> $23.07M (much smoother)\n\nRule 3: Geometric Smoothing (w = 0.7 weight on prior spending, 0.3 on current rule)\n- Year 1: 0.7 x $25.0M + 0.3 x $20.75M = $17.5M + $6.225M = $23.73M\n- Year 2: 0.7 x $23.73M + 0.3 x $23.45M = $16.61M + $7.04M = $23.65M\n- Spending volatility: $25.0M -> $23.73M -> $23.65M (very smooth)\n\nRule 4: Yale/Hybrid (70% inflation-adjusted prior + 30% simple rate)\n- Year 1: 0.7 x ($25.0M x 1.025) + 0.3 x $20.75M = $17.94M + $6.225M = $24.16M\n- Year 2: 0.7 x ($24.16M x 1.025) + 0.3 x $23.45M = $17.33M + $7.04M = $24.37M\n- Spending volatility: $25.0M -> $24.16M -> $24.37M (smoothest)\n\nSummary Table:\n\n| Rule | Spending Stability | Capital Preservation | Inflation Protection | Complexity |\n|---|---|---|---|---|\n| Simple rate | Low | High | None | Low |\n| Rolling average | Medium | High | None | Low |\n| Geometric smoothing | High | Medium | Partial | Medium |\n| Yale hybrid | Highest | Medium | Built-in | High |\n\nExam Guidance: The CFA curriculum emphasizes that the Yale/hybrid rule is most commonly used by large endowments because it best balances all objectives. However, know all four rules and be prepared to calculate spending under each.\n\nExplore endowment management in our CFA Level III course.