The Yale spending rule

Endowment discussions often refer to the "Yale spending rule," or the "Yale-Stanford spending rule," or the like. This is a weighted combination of some percentage of the prior year spending and some percentage of the (average) portfolio value.

The most recent Yale Endowment Report gives details of their current implementation:

The target spending rate approved by the Yale Corporation currently stands at 5.25 percent. According to the smoothing rule, Endowment spending in a given year sums to 80 percent of the previous year’s spending and 20 percent of the targeted long-term spending rate applied to the fiscal year-end market value two years prior. The spending amount determined by the formula is adjusted for inflation and constrained so that the calculated rate is at least 4.5 percent, and not more than 6.0 percent, of the Endowment’s inflation-adjusted market value two years prior. The smoothing rule and the diversified nature of the Endowment are designed to mitigate the impact of short-term market volatility on the flow of funds to support Yale’s operations. 

This is more-nuanced than the common characterization of a Yale-style blended spending approach. EndowmentInvestor notes:

1. The 5.25 percent rate is high relative to other endowments, but is supported by their outstanding investment performance.
2. The 80 percent weighting on the prior year is higher than the typical 70 percent. This smooths spending more, which is good for budgeting.
3. The 20 percent weighting is applied, not to a moving three-year average but, to the portfolio value 2 years earlier. While it seems like this merely picks the midpoint of the typical three-year window, it affords greater budgeting certainty since this value is known two years earlier and is not subject to revision in the last remaining months of a 36-month window.
4. The way this paragraph is written, it seems the inflation adjustment is applied to the whole spending calculation. This is different from the typical application of inflation to the prior-period spending component only.
5. Lastly, the 4.5 to 6.0 percent channel is an innovation from the typical implementation. This corridor technique, borrowed from the actuaries working with pensions, further smooths spending which is good for budgeting AND precludes overspending in good times.

 As always, there's interesting detail that rewards a close reading of the annual Yale Endowment Report.