From the December 2007 issue of Wealth Manager Web • Subscribe!

College Costs

College and university endowment funds had a banner year in 2006. The average fund earned a 10.7 percent investment return, according to the National Association of College and University Business Officers. Not only are many funds earning double digit investment returns, but a rising stock market has also made alumni more generous. In 2006, endowments grew significantly at schools such as Purdue University (11.4 percent), the University of Chicago (17.6 percent) and New York University (14.6 percent) including both market returns and new gifts.

But how much of this money trickles down to make college more affordable? The College Board says tuition at four-year private schools grew 5.9 percent for 2006-2007. (The increase at public colleges was 6.3 percent.) Many observers believe colleges and universities should spend more of their wealth to keep tuition down. And some lawmakers agree.

In response to charges that higher education has been "hoarding wealth," the Senate Finance Committee is considering proposals that would require institutions with endowments over $500 million to spend at least 5 percent of their endowment annually. The committee is also considering a recommendation to tax endowments if the institution they support increases tuition by more than the rate of inflation.

Higher education groups have bristled at these suggestions, telling the committee in written testimony that forcing them to use their private endowments in a specific way is "short-sighted" and would ultimately reduce the nation's educational resources. They say their ability to manage their resources as they see fit is the best way to meet their education, research and public service missions.

Endowments provide colleges and universities with money to offer scholarships, hire faculty, conduct research and construct new facilities. They represent hundreds of individual contributions invested to support the institution's mission. Matthew W. Hamill, senior vice president of the National Association of College and University Business Officers, says endowments--together with annual giving--are the backbone of higher education finance. "No student pays the full cost of their education--even if they pay the full posted tuition and don't receive any financial aid," Hamill says. Endowment earnings and donor generosity cover the difference between the tuition charged and the institution's full costs.

He adds that endowments help provide targeted financial aid to students in the form of institutionally provided grants. "Schools can offer those grants largely due to their endowment income," he notes. "Some schools with large endowments are even able to offer students with a family income of less than $60,000 to $70,000 a free education."

Hamill says parents should understand that endowments--by virtue of the donor's interests--may be restricted. "A school that receives a gift to support a faculty position or build a new biology building is morally and legally obligated to honor those restrictions." The net effect is part of the general subsidy Hamill says all students receive from a school's endowment. "Because the school has less flexibility in allocating its endowment resources, part of the challenge of managing its endowment and budget is balancing those obligations," he points out.

Joseph Hurley, CPA and the founder of SavingforCollege.com, says education costs continue to increase at a pace greater than inflation despite growing endowments. "The historical cost increase is about 6 percent per year, with no indication it will change in the near future. There is," Hurley adds, "still a large segment of students who aren't able to attend anything other than community college because of price."

So why don't growing endowments translate into lower tuition or smaller increases? Hamill says institutions with large endowments tend to be complex and to do significant amounts of research. "Schools would love to be able to do cutting edge research and keep tuition from going up. But it's not always possible to balance these competing missions," he says.

Is a solid and growing endowment important when choosing a college? According to Hurley, "A good endowment typically means there is more institutional aid available for students, and the school is in a good position to provide grants rather than loans to students who need them." Endowments, he says, also allow for campus improvements.

Hamill agrees endowments are a stabilizing factor that families should take into consideration. "A generous endowment suggests more stable tuition in the future as the institution manages its endowment to provide a steady source of income to support the operating budget." While a large endowment doesn't guarantee tuition won't go up, it will probably prevent sudden swings, he adds.

It's too soon, Hamill says, to speculate what might be in any Senate Finance Committee bill. "We've been explaining to the committee staff how endowments work so they understand their role in the life of a college," says Hamill. Even if endowments escape mandated spending rules, the current spotlight is likely to result in increased disclosure so students and parents better understand how institutions use their endowment resources.

Peter D. Fleming is a freelance business and investment writer in New York City. He was a Senior Editor of the Journal of Accountancy for 16 years.

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