Can I check for question 1 IPS of foundation (Prairie Foundation), would the requirement to maintain 4.0% of spending reduce its ability to take risk, because failing which, it wouldnt be able to maintain its tax exempt status.
Endowment has no such requirement.
Its a moot point given that we have already calculated the required return for the endowment and found it to be higher than that of the foundation
Understand that, but with the volatility of the earnings in the future, if there ever exists a chance that the asset value’s decline couldn’t justify that the 4 percent spending be maintained, and thus losing the tax exempt status (for that year I suppose), isn’t this consideration a factor that reduces its risk tolerance?
Think about what you’re saying…if a market crash occurs and the foundation’s asset value takes a nosedive, say 50%. In absolute terms that 4% spending requirement is also going to drop. So this really isn’t a huge risk. On top of that, you are drawing on a ton of what ifs and scenarios that aren’t related to the question.
Does a spending requirement reduce the ability to take risk? Sure, in a generic sense. If you have two identical organizations, one organization with a spending requirement and one without…clearly the spending requirement reduces risk tolerance. In the world the CFAI has built for us for this case, it is irrelevant.
I think I see where you’re coming from, inchvbeam. It seems like the spending requirement of the foundation is a “hard” requirement, while the endowment is more flexible. In this case, I think both requirements are “hard” requirements. The primary mandate of the endowment is to “fully fund the subscription costs in perpetuity”. It’s the minimum required return— The entire endowment exists for this purpose. It’s not similar to those IPS where a couple may or may not donate an x amount.
Given this, the 7.4% minimum requirement of the endowment makes it less risk tolerant than the foundation with a spending requirement of 4%.
I thought it is ambiguous: risk tolerance may go down in a crisis for the reasons you stated, but risk tolerance might go up because the required return increases to meet the target return, requiring a higher risk target?