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What is a college endowment? And why should you care?

Recently, students at Harvard published an article in The Crimson in which they lambasted the poor performance of the Harvard endowment as “unacceptable” - calling on the University to make personnel changes to ensure that Harvard did not continue losing the endowment race to its chief rival. Go Bulldogs.

There has been a lot of talk and speculation about this article. In particular, it has been criticized as the lamentations of spoiled, over-privileged children who have nothing better to do than bemoan the fact that Harvard lost some ground financially, despite maintaining a commanding lead as the richest university in the world.

One thing that strikes as odd is that so few people seem to understand the question of what is a college endowment, how it is used, and why it matters to students, faculty, and prospective applicants. I’ll take each of these topics in turn.

1. What Is a College Endowment?

Here’s a little finance lesson for you: think of an endowment as a retirement account. There is a “principal” (the amount of money in the account) and an annual return (how much money is made investing that principal each year). In addition, because you have to live off of that principal for years to come, you can’t simply spend it all. So what do you do? You restrict your spending such that you are mostly spending your “returns” and only occasionally dipping into your principal.

Thus, if you have $100 in your retirement account, and every year you make an additional $10 investing that money, you will try to only spend $10, and not dip into the $100 “principal”. Otherwise, the next year, you will have less than $100 in your retirement account, and your investment returns will therefore be less than $10 (because you have less money to invest), and you will have to deplete even more of your principal.

It is much the same with university endowments, except several universities have endowments in excess of $10 billion. Each year, they use the investment returns from those endowments to hire professors, build and maintain facilities, give financial aid to students, and generally fund the operations of the university. While they try to steer away from dipping into their principal, most schools have either internal or state-mandated policies permitting them to use a certain percentage of their endowment’s principal each year.

To give you a better sense of how large these endowments can be, I’ve included a table below (from U.S. News and World Report) of the United State’s 10 largest university endowments: 

2. How do Endowments Come to Be?

What is a college endowment? How does it begin? Endowments start and grow through two primary mechanisms. The first is donations. If you’ve graduated from college, you already know that a huge percentage of the mail and communication you get from your alma mater concerns alumni donations and giving. Last year, for example, Harvard received almost $1 billion in alumni donations - adding to its already massive $37.6 billion endowment.

Alumni donations are one of the principal reasons why universities prefer students with a “legacy” at their school. Simply put, these families are the most likely to give generously throughout their lifetimes. As a result, their children tend to receive preferential treatment in the admissions process.

The second way endowments grow is through reinvestment. Say, for example, that Harvard’s endowment as an annual return of 10%, meaning that the investment of its endowment produced $3.76 billion in income that year. Now assume that Harvard only needs to spend $1 billion to operate the university. So what happens to the other $2.76 billion? It gets added to the endowment. And the following year, Harvard can invest even more money, and make an even greater return for its endowment.

3. Should We Care About Endowments?

In a word? Yes.

Let’s consider two different sets of schools in the tables below. The first are familiar as the perennial top-five schools from the U.S. News and World Report college rankings. The second set of schools are all world-class institutions, but typically rank between 15-20 in the college rankings.

*Data on CPS obtained via Collegemeasures.org

Notice anything about the endowments? Well first, it just so happens that the five highest-ranked universities also happen to be the exact same universities with the five largest endowments in the country.

Coincidence? Not likely.

Perhaps the easiest explanation of this phenomenon is that the endowment impacts a lot of variables - outside of things such as a school’s average SAT score - that are taken into consideration when a university is ranked: quality of professors, the amount and quality of research produced at the university, the quality of the facilities, the faculty:student ratio, and so on.

Now let’s look at cost per student. Roughly speaking, cost per student (CPS) tells us how much money a university spends for every student enrolled there. Although not perfect, it can serve as a rough measure of how many, and what quality of resources a university invests in its students. For example, a higher cost per student might indicate that professors are better paid (which would attract top talent), or that there is a higher professor-to-student ratio, which would suggest that students have more access to their professors.

As you might expect, cost per student is, on average, 37% higher at the schools with larger endowments.

Ultimately, then, when asking, “what is a college endowment,” we care about it - and how it is invested - for two reasons. First, because the endowment plays a significant role in the ranking of universities. Schools with larger endowments tend to stay at the top of the rankings. These rankings, in turn, affect the prestige and perceived significance of our degrees after we graduate.

Secondly, we care about the endowment because it has a very real impact on the quality and quantity of resources made available to students. At Yale Law School, for example, the endowment is $1.2 billion for a little less than 600 students. A professor once told me that this amounted to a cost per student of almost $250,000 a year. As a result, students at Yale Law School have an incredible number of resources at their fingertips. These resources attract the best and brightest students.

So, as you think about applying to schools, you might ask yourself “what is a college endowment?” Do these funds factor into rank, resources, and prestige? Certainly. These endowments are absolutely reflected in college rankings.

But as you build your best college list for you, endowments might not be the first thing on your mind. Rather than thinking only about “what is a college endowment,” consider the question of “what do these endowments provide students?” First-class professors, a good professor:student ratio, access to great facilities, and a number of other factors are things that you should think about in finding the best school for you.

Money isn’t everything. But in terms of resources that schools can offer students, I would say that it doesn’t hurt…