I’m finding it a little difficult to get my head around this, but is the primary aim of an endowment not to have to spend any principal and to fund any spending from return? Hence why they have spending rules (i.e. smoothing)? Or are spending rules just to ensure there is no liquidity issue for the endowment? Also for foundations, my understanding is that they have the same goal of not spending principal, however they can be for a short horizon and thus use up principal for large projects. Would a foundation only spend principal if it was a short horizon foundation running down over time?
I believe the spending rules in the endowment are set up so that you balance the endowment so that it will benefit current beneficiaries and also the remainderman. It wants to make sure you manage for now and the future, so the spending rules keep you in check. You are correct in that they should avoid spending principle if possible. For foundations, I think they would have to tell you in a problem they need to spend principle on a project, or that this foundation has a 10 year lifespan. In either case, spend principle as necessary, but always remember to balance this years needs with future years needs. Hope this helps, there is a lot of gray area here.
So spending principal isn’t necessarily prohibited if there is a lumpy project payment as long as the over spend is covered in following years?
Spending principal shouldn’t jeopardize the long-term perpetuity of the endowment. But if the exam tells you your foundation is going to fund a new library to Yale, then you are going to do what it tells you and take it out of the principal. The exam will probably be specific in telling you this.