By Gene T. West, RBC Wealth Management
When we discuss the best practices for investing association reserve funds in today’s world, it is probably best to review a bit of history with this topic. Community Associations began to take hold during the 1970s. During the 1980s, association reserve accounts began to grow. At the time, interest rates were substantially higher than today. The 10-year US Treasury Note was yielding 9.04% on January 2, 1986, compared to about 3% +/- today. Virtually all the reserve assets of HOAs in the 1980s were sitting in bank savings accounts or money market accounts when the 10-year US Treasury Note was as high as 12.02%. Since ‘real’ rates were so high, no one cared about ‘investing’ the funds. The 1990s brought lower rates and slightly more sophisticated investing by community associations. In 1996, the 10-year treasury had declined to 5.58%. Laddering, or staggering maturities became popular. This was, and still is, a great way to provide liquidity and may guard against the risks associated with dramatic moves in interest rates. Making use of other US government securities like GNMA mortgage bonds also came into play. By 2005, the 10-year treasury yield had dropped further to 3.89%. Using a financial advisor specializing in HOAs was becoming more popular, and a small percentage of communities were using mutual funds. On 7/8/2016, the 10-year treasury closed at a then record low yield of 1.36%. Association boards were patiently waiting for rates to go higher. But they didn’t. From 2016—2021 associations struggled with the concept that inflation was outpacing the earnings of the reserve account, and most all associations were losing purchasing power on their reserve fund assets (inflation being higher than the rates earned) every day. Most association boards are now discussing this concern. The fact is, if earnings in a reserve account do not keep up with inflation, there is generally only one way of making up this difference. That is by raising assessments. Remember, every dollar you earn in a reserve account is one less dollar that needs to be assessed to owners.
Today, we spend a lot of time discussing the definition of ‘risk.’ Is risk defined as the possibility you could lose money on an investment? Or is risk defined as the possibility that you could lose purchasing power because of inflation? Each board must prioritize its concerns on this topic.
When it comes to ‘best practices’ in today’s world, we see boards taking one of two avenues. Those boards who define risk as the chance you could lose money, will continue to invest reserve funds as we have done in the past: laddering CDs, treasuries, and making use of other government securities like GNMA’s. The boards that view risk as not keeping up with inflation will invest a portion of their reserve funds in non-US Government instruments in order to obtain a higher return.
The bottom line on reserve accounts is that this money is being put aside to spend at a future date. Associations must always have cash available when assets need to be repaired or replaced. Laddering CDs or treasuries can be essential in any investment strategy. Using a financial advisor specializing in Community Associations may assist in improving the chances of the association having a strategy. It may also help fulfill any obligation that each board member has to their community and can assist with a more proactively maintained community.
Gene T West
Senior Vice President - Financial Advisor
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Interest rates sourced from FactSet web application.
