Is it time to review your spending policy?


Well-managed investments play a critical role in the sustainability of many organizations, including nonprofits. A key element is your nonprofit’s spending policy, essentially the formula used to determine how much of the value of your investments will be tapped each year for such expenses as operating costs and capital projects.

It’s generally advisable to stick with your spending policy once it’s established, but circumstances can arise that support review and potential revision. With the past two years of unprecedented events, both operationally and financially, it might be time for your organization to reconsider its spending approach.

Different techniques

Unfortunately for leaders who prefer to focus on their mission rather than their finances, there’s no one-size-fits-all optimal spending policy. But several types have emerged, each of which have pros and cons. They include:

Fixed rate. Also known as the simple spending rule, this approach specifies a spending rate that’s applied annually to the beginning-period market value of the investment portfolio. It’s simple to understand and apply but can result in big swings in spending from one year to the next based solely on the investment portfolio’s performance the prior year. In a multi-year period of strong investment performance, the fixed-rate approach can lead to the highest spending increases compared with alternative techniques, which undermines the portfolio’s growth.

Rolling average. The organization applies a spending rate to a moving market value average of its investment portfolio, usually determined over a three-year period. A rolling average generally ensures more consistency in spending from year to year but is vulnerable to market volatility. For example, this rule could dictate more spending than would be wise in a year when the portfolio value has dropped substantially or produce a low spending amount when nonprofits need extra financial support.

Inflation-based. With this method, the nonprofit sets an initial dollar amount for spending, which is then adjusted annually for inflation (sometimes with a cap and a floor based on beginning market value). It can simplify budgeting, stabilize spending and help grow the investment portfolio because the spending amounts tend to be smaller — but it doesn’t take into account the portfolio’s market value. On the other hand, it can facilitate more spending in challenging times when compared with the rolling average (of course, higher spending also can eat into the portfolio).

Geometric spending. The formula for geometric spending is complicated, but it reflects movement in both inflation and the market. Although it can be difficult to calculate, a geometric spending rule reduces volatility between years and can lessen the impact of market declines on spending.

Hybrid. This approach generally considers both inflation and market value. A large chunk of the yearly spending is based on an inflation adjustment to the previous year’s spending. The remainder is based on, for example, the application of a fixed rate to the portfolio’s market value or a percentage of the rolling-average rule amount. Hybrid spending policies tend to result in stable spending, in terms of both dollar amounts and the percentage of portfolio value.

Note that each of these policies generally should include a provision allowing spending to exceed the prescribed amount as necessary, as determined by the board of directors or other authorized party.

Right approach for you

With the environment for many nonprofits still far from “normal,” a disciplined approach to spending and investing is vital. Your accountant or financial planner can help you select the best policy for your current circumstances based on the long-term goals for both your investments and your organization. You can always reach out to Sechler Morgan CPAs for advice at