The endowment rule: how Yale spends a portfolio meant to last forever

Here’s a thought worth borrowing: a university endowment is a retiree who never dies. Yale has to pay salaries and keep the lights on every single year, forever, out of an investment pot that must never run dry and must keep pace with inflation across centuries. That is the decumulation problem in its most extreme form, and the great endowments have spent decades refining an answer. Their solution — the spending-smoothing rule — is the sixth stop on our withdrawal tour, and it solves a problem the pure percentage method couldn’t: how to respond to markets without letting your income lurch around every year.

The problem it solves

Recall the dilemma. A constant-dollar income ignores the portfolio and risks depletion. A pure percentage income protects the portfolio but jumps around violently. Yale can’t accept either. It can’t ignore a market crash (that would risk the endowment’s survival), but it also can’t slash faculty salaries by 30% because the market had a bad year — nearly two-thirds of the operating budget is people, and you can’t smooth a payroll with a spreadsheet apology.

So the endowment needs an income that drifts toward what the portfolio can support, but gradually — absorbing shocks over several years rather than passing them straight through to next year’s budget. That’s exactly what smoothing does.

The formula

Yale’s rule is a weighted blend of two numbers: what you spent last year, and what a fixed percentage of the portfolio would be. The published formula is roughly this — each year’s spending equals 80% of last year’s spending (bumped up for inflation) plus 20% of a long-term target rate applied to the portfolio’s value.

Read it slowly and the genius shows. The 80% weight on last year’s spending is the anchor — it’s what keeps your income stable and predictable, because most of this year’s figure is simply last year’s figure carried forward. The 20% weight on “target rate × portfolio value” is the steering — a gentle tug pulling your spending toward whatever the current portfolio can actually sustain. Every year, only a fifth of the gap between your current spending and the portfolio’s “ideal” spending gets closed. Shocks bleed in slowly instead of hitting all at once.

Yale pairs this with a long-term target spending rate around 5.25% and hard limits — the resulting payout is constrained to sit within a band (Yale’s is 4% to 6.5% of the endowment’s value), so the smoothing can never drift so far from reality that spending becomes either reckless or absurdly stingy.

A worked example

Say you spent £50,000 last year, inflation was 3%, and your portfolio is now worth £900,000 with a 5% target rate. The two ingredients: last year’s spending inflated is £50,000 × 1.03 = £51,500; the portfolio-based figure is 5% × £900,000 = £45,000.

Blend them 80/20: (0.8 × £51,500) + (0.2 × £45,000) = £41,200 + £9,000 = £50,200. Note what happened. Your portfolio fell, and the pure-percentage number wanted to drop your income to £45,000 — a painful cut. But the smoothing formula, anchored 80% to last year, only nudged you to £50,200. You barely felt the crash this year. If the portfolio stays depressed, next year’s calculation starts from this lower base and tugs you down a little further, and the year after that — the pain arrives, but spread thin across several years instead of dumped into one. That’s the entire point: turn a cliff into a gentle slope.

Strengths and weaknesses

The strength is a genuinely stable yet responsive income — the holy grail this whole series has been circling. Smoothing gives you most of the predictability of constant-dollar with most of the portfolio-protection of percentage withdrawals, because it responds to markets but refuses to overreact. It’s how the most sophisticated institutional investors on earth actually spend, which is a decent endorsement.

The weaknesses are honest ones. Because the anchor is so heavy, smoothing is slow — in a prolonged downturn it keeps your spending elevated for years before fully adjusting, which strains the portfolio during exactly the dangerous early period when sequence risk bites hardest. The lag that protects your lifestyle also delays the correction that protects your pot. And it’s more fiddly to compute than a flat rule: you need last year’s actual spending, an inflation figure, and the portfolio value, every year, blended in the right proportions. It rewards record-keeping.

Who it suits, and adapting it

The endowment rule suits a retiree who prizes a steady income above all but refuses to fly blind — someone with mostly fixed spending who still wants the plan to acknowledge reality, just calmly. It’s especially apt if you’re managing a genuinely long or perpetual horizon: an early retiree funding fifty years, or someone explicitly planning to leave the portfolio to heirs or charity. You can also tune it — a heavier anchor (say 85/15) makes income even smoother and the portfolio response even slower; a lighter one moves it back toward pure percentage.

Strata doesn’t ship the endowment formula as a named preset the way it does Fixed Dollar or Guardrails, but the idea slots neatly alongside them, and the tools that matter — a reconciled portfolio value and a faithful record of what you actually spent each year — are exactly what smoothing needs to run. If you want to experiment, the smoothed figure is a two-line calculation on top of the portfolio value Strata already tracks for you across all your accounts.

Next we leave the percentage rules behind entirely and look at a structural strategy that fights sequence risk with a completely different weapon — dividing your money into time-based buckets. That’s the bucket strategy. Or build your portfolio and start keeping the spending record a smoothing rule would need.