The most consequential governance decision most trust and foundation boards make is one they rarely discuss as a governance decision at all: how much of the portfolio's return to spend, and how much to preserve for the future.
A board that spends 5% of its capital each year will deliver a very different outcome over thirty years than one that spends 4%. The difference is not marginal. It compounds relentlessly. And for trusts and foundations with a perpetuity mandate, getting this decision right is the difference between an institution that sustains its mission indefinitely and one that slowly, invisibly, erodes its capacity to serve.
Most boards have a spending rate. Fewer have a spending policy: a deliberate, documented framework that connects the spending rate to the portfolio's expected return, the trust's reserves, and the long-term sustainability of the granting programme. And fewer still have a reserving policy that specifies what the trust holds back, why, and under what conditions those reserves can be drawn upon.
This guide makes those connections visible. It provides the analytical framework that allows a board to set its spending rate as a governance decision rather than an inherited assumption, and it introduces the reserving policy as a governance tool that most advisory relationships never bring to the surface.
The concepts here will be familiar to boards that have worked through these questions with an experienced investment partner. For boards that haven't, this may be the first time the spending decision has been framed as part of a connected investment governance system. Both audiences should find something useful: a framework to apply, a question to ask, or a benchmark to test their current approach against.
In This Guide
- The Spending Decision and Intergenerational Equity
- The Spending Rate Impact Table
- See How These Decisions Connect (Interactive)
- Smoothing Mechanisms
- A Framework to Take to Your Next Meeting
The Spending Decision and Intergenerational Equity
The perpetuity mandate creates a structural tension that every trust and foundation board must navigate. Current beneficiaries benefit from higher spending. Future beneficiaries benefit from capital preservation. Every spending decision tilts the balance between the two, and because the effects compound over decades, even small tilts can produce large consequences.
This tension is not abstract. A trust that distributes 6% of its capital in a year of strong returns may feel that it is being appropriately generous. But if markets correct the following year, that higher spending base has permanently reduced what future beneficiaries will receive. The maths of perpetual capital is straightforward but unforgiving: a trust must earn enough, on average over time, to cover its spending rate plus inflation plus investment costs. A spending rate that exceeds the portfolio's long-term real return is a transfer from the future to the present.
The concept that frames this tension is intergenerational equity. An endowment managed for perpetuity should preserve its purchasing power so that future generations receive the same level of support as the current generation. This does not mean the spending level never changes. It means the capital base, adjusted for inflation, should remain sufficient to sustain equivalent spending indefinitely.
Intergenerational equity is not a formula. It is an ethical principle that informs the spending policy. A board that understands the principle can make deliberate trade-offs: spending slightly more now to address an urgent community need, with a clear plan to restore the capital base over time. A board that hasn't been shown the principle often makes the same trade-offs without realising they are trade-offs at all.
The spending rate is where this principle meets governance practice. And the impact of that rate, compounded over decades, is where most boards find the analysis genuinely illuminating.
The Spending Rate Impact Table
This table shows what happens to the real (inflation-adjusted) value of an endowment over time at different annual spending rates. The figures are indexed to 100 at inception.
Real endowment value at different spending rates, indexed to 100 at inception
| Spending Rate | After 20 Years | After 30 Years | After 50 Years |
| 3.5% | 110 | 116 | 128 |
| 4.0% | 100 | 100 | 100 |
| 4.5% | 90 | 86 | 78 |
| 5.0% | 82 | 74 | 61 |
| 5.5% | 74 | 64 | 47 |
| 6.0% | 67 | 55 | 36 |
Illustrative. Assumes a long-term real return of 4% per annum after inflation and all investment costs, with spending applied to beginning-of-year portfolio value. Actual outcomes will vary with market conditions, return sequence, portfolio construction, and the specific spending rule used. The purpose of this table is to show the shape of the outcome, not to provide financial projections.
Three things stand out.
First, the compounding effect is dramatic. The difference between a 4% and a 5% spending rate looks modest in any single year. Over fifty years, it is the difference between maintaining the endowment's purchasing power and losing nearly 40% of it. A board that inherits a 5% spending rate and never revisits it may not notice the erosion for a decade. By the time the trend is visible, a significant portion of the capital has already been consumed.
Second, the relationship is not symmetrical. A trust spending 3.5% grows its real capital modestly over time, building an increasing buffer against adverse markets. A trust spending 5.5% loses capital at an accelerating rate, because each year's spending is drawn from a smaller base, which reduces future returns, which further reduces the base. The trust that is already spending too much is the one least able to absorb a bad year.
Third, the "right" spending rate is not a universal answer. It depends on the trust's specific circumstances: the expected return of its portfolio, the nature and flexibility of its granting commitments, whether it receives ongoing contributions from other sources, and the board's view on intergenerational equity. A trust with other revenue streams may sustainably spend more from its investment portfolio than one that relies on investment returns alone. A trust with flexible granting commitments has more room to adjust than one with multi-year contractual obligations.
What the table does provide is a shared analytical framework. A board that can see the long-term trajectory of its current spending rate is a board that can make an informed governance decision about whether that rate is appropriate. And a board that has never seen this analysis should ask why.
See How These Decisions Connect
The table above shows the long-term impact of different spending rates. But in practice, the spending rate does not exist in isolation. It interacts with the trust's risk appetite, which determines the strategic asset allocation and expected return, which in turn determines whether reserves are being built or consumed.
What makes this system genuinely challenging to govern is that the required response is often counterintuitive. When reserves are low and the trust most needs to reduce spending, that is precisely when community need is typically highest. When the portfolio is under pressure and risk appetite should logically increase to rebuild returns, that feels reckless to a board watching capital erode. The governance squeeze operates in both directions, and boards that have not seen it before often find it the most useful insight in this entire framework.
The tool below makes that system visible. Adjust the two inputs and watch how the 15-year capital projection responds. The commentary explains what each outcome means for governance, including where the squeeze applies.
Smoothing Mechanisms
Most trusts do not, and should not, calculate their annual spending as a simple percentage of the portfolio's current market value. Market volatility would translate directly into grant volatility, which is disruptive for recipients and difficult for boards to manage. A trust that grants $5 million this year and $3.8 million next year, because markets fell 20%, creates real problems for the organisations and programmes that depend on that funding.
Smoothing mechanisms decouple annual spending from annual market movements. The three most common approaches each balance stability against responsiveness differently.
Rolling average. The trust sets its spending as a target percentage of the portfolio's average market value over a rolling period, typically three to five years. In a year of strong returns, the average rises gradually rather than immediately; in a year of poor returns, the average falls gradually. This is the most widely used smoothing mechanism among endowments and community trusts because it is straightforward to calculate, easy to explain to stakeholders, and provides meaningful stability without ignoring the portfolio's actual performance trajectory.
Inflation-linked with bounds. The trust sets a base spending level in dollar terms and adjusts it annually for inflation, subject to upper and lower percentage limits relative to the portfolio's current market value. If the portfolio grows significantly, spending rises with inflation but does not spike; if the portfolio falls, spending decreases to stay within the percentage ceiling. This approach prioritises spending predictability over spending maximisation, and suits trusts whose granting programmes benefit most from year-to-year stability.
Hybrid approaches. Some trusts combine elements of both, applying a weighted average of the rolling-average calculation and the prior year's inflation-adjusted spending. Others use a ratchet mechanism, where spending increases with portfolio growth but does not decrease unless the portfolio falls below a specified threshold. Hybrid approaches can be tailored to a trust's specific governance preferences but add complexity to the spending policy, which can make it harder for new trustees to understand how the spending rate is determined.
The choice of smoothing mechanism is a governance decision. It involves a trade-off: more smoothing means greater stability in annual distributions, but it also means a slower response to both rising and falling markets. A trust that smooths aggressively may continue spending at an unsustainably high rate for several years after a market downturn, because the smoothing mechanism masks the decline. A trust that smooths too lightly may pass market volatility through to its grantees unnecessarily.
What matters most is that the board understands how its spending is calculated, why that method was chosen, and what happens to the calculation when markets move significantly in either direction.
A Framework to Take to Your Next Meeting
If this guide achieves one thing, it should be this: the next time your board discusses its annual spending, the conversation should include the long-term sustainability of that spending, not just the level.
Three questions to bring to your next investment committee meeting:
What is our current effective spending rate?
Total distributions over the last twelve months, divided by the portfolio's average market value over the last three years. If the answer is not immediately available, that itself is informative. A board that doesn't routinely track its effective spending rate may be making spending decisions without a clear view of the long-term trajectory.
How does our spending rate compare to the portfolio's expected long-term real return, after fees and inflation?
If the spending rate exceeds the expected real return, the trust is spending down its capital over time. That may be a deliberate decision, but the board should know it is happening and have a view on what that means for future beneficiaries.
Do we have a formal spending policy, or are we setting the grants budget on an annual discretionary basis?
A formal spending policy, with a documented target rate, smoothing mechanism, and review trigger, provides governance discipline that annual discretionary budgeting cannot. It also gives the board a framework for explaining its spending decisions to beneficiaries and stakeholders.
If any of these questions surface uncertainty, the spending policy may not be receiving the governance attention it deserves. This is not unusual. Many advisory relationships focus on portfolio returns and manager performance, and the connection between the investment function and the spending decision is left implicit rather than surfaced as a governance question. A board that asks for this analysis explicitly will find it genuinely useful.
Full Guide
Continue Reading
This is the public preview of our guide on spending policy and reserves for perpetual capital.
The full guide includes the reserving policy framework (target levels, purpose categories, draw-down triggers, and replenishment mechanisms), a detailed analysis of how risk appetite, asset allocation, and spending sustainability connect as a governance system, the concept of sequence-of-returns risk and why it matters for spending portfolios, spending-aware investment reporting, and a board self-assessment.
Or visit shawandpartners.co.nz/spending-policy
