How can liberal arts colleges afford to spend more than they charge?

And if they have giant endowments, why do they have to charge tuition at all?

Last week’s post ended with a chart that showed that the top liberal arts colleges spend a LOT more per student than the lower ranked schools, even more than the full sticker price for tuition, fees, room, and board.

Today’s post asks: How can liberal arts colleges afford to spend more than they charge?

Answer: Endowments.

“Endowment” is a fancy name for the big piles of money an institution has accumulated over time. Institutions invest their piles of money in various assets that pay them a return each year. They then spend part of that return on their current students.

Just how big are those endowments? Very.

The top 10 liberal arts colleges had an average of $1.12 million per student in 2022. These colleges enrolled an average of 1446 students each, so the average total endowment was $3.42 billion.

It will not surprise you to learn that there’s a lot of variation in the size of endowments across schools. The next 11-25 liberal arts colleges had an average of $604k per student, the next 26-50 had $447k per student, and the last 50-100 had $263k per student.

Ok, just wait one minute, you may be thinking. $1.12 million per student? Why are these schools charging tuition at all? Why can’t they just spend down their “endowment,” a.k.a. ginormous pile of money? Even the less endowed schools have $263k per student. Surely they can increase financial aid for my kid.

Not so fast. Nonprofit colleges and universities are required to maintain or increase the size of their endowment in perpetuity. They’re literally not allowed to spend so much that the principle shrinks. Why?

Think of it this way. You save for retirement, right? (You really should do that.) You’re trying to save up a pile of money and invest it, so that one day you can stop working and live off the investment returns. When you spend less than your pile of money earns, your pile grows. When you spend more than your pile earns, your pile shrinks. When you’re 99, go ahead and spend all of your investment returns, because you don’t need your pile to last much longer. But if you retire at 59, you should be spending less than you earn because you hope not to die soon and an increasing pile will surely provide for you.

Colleges are doing the same thing, but they hope to never die. They want their piles to grow, or at least not shrink, forever.

In fact, nonprofits with endowments are required by law to manage their funds “prudently,” according to the Uniform Prudent Management of Institutional Funds Act.

The purpose of UPMIFA is to protect the assets of nonprofit institutions from misuse and loss. – Carnegie Investment Counsel

Every endowed nonprofit is required by UPMIFA to set a policy about how much of their pile-o-money they will spend each year, and that policy must protect the value of the fund over time even through economic volatility. Meaning: they must spend less from the endowment than the endowment earns. Most colleges choose to withdraw 4-5% of the value of their endowment. Why? Mr. Money Mustache explains it well.¹

At the most basic level, you can think of it like this: imagine you have your ‘stash of retirement savings invested in stocks or other assets.’ They pay dividends and appreciate in price at a total rate of 7% per year, before inflation. Inflation eats 3% on average, leaving you with 4% to spend reliably, forever. – Mr. Money Mustache

You can find out what policy a college has set and why by looking at their audited financial statement. I believe every nonprofit is required to post their financial statement on their website, and in practice I’ve always been able to find a recent one. For example, Colorado College’s 2022-23 financial statement is here. Carleton’s is here. Reed’s is here. William’s is here. Just google “Name of College financial statement” and you should be able to find it.

Different colleges have chosen slightly different payout rates and schemes. For examples, I made up this table of the rates in my college’s peer group.

Ok, so let’s get back to why even the most well-endowed schools can’t stop charging tuition. The average top 10 liberal arts college has $1.12 million in endowment funds per student. By law they’re only allowed to withdraw around 4-5% of that each year; $44,800-$56,000 per student per year. That’s about half of their expenditures per student. The average SLAC ranked 51-100 has $263k in endowment funds, leading to a payout of $10,520-$13,150 per student per year. That’s only about 20% of expenditures per student. If these schools want to maintain their current level of expenditures, they have to keep charging tuition, even if they have giant endowments.

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I’ll leave you with one last chart: endowment per student by each school individually. It turns out there’s a lot of variation, even within tiers. Just eyeballing it, it looks like there’s more variation within tiers than between then. I didn’t know that! And what is up with those outliers, like Soka University with an endowment of more than $4 million per student in the Top 26-50 category, and Principia College with an endowment of $1.8 million per student in the Top 51-100 category. Fascinating facts to chase down another day. Please tell us more if you know it in the comments!

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There’s a lot more to say about endowments, about things like restricted funds, unrestricted funds, quasi-endowments, and more. But we’ll leave that for another time.

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1. Mr. Money Mustache is famous for saving up enough money and adjusting his lifestyle to retire in his 30s. I had a friend in my mid-20s who was obsessed with him. Now in our early 40s, both of us are still working.