One of the most important responsibilities of any Homeowners Association Board is to develop and maintain a reserve fund. The HOA reserve fund encompasses assets set aside for emergency repair needs and capital improvements, including projects that are beyond the scope of the normal, operational budget.
A question that many Boards face is exactly what to do with their reserve fund when it’s not actually needed. Do you just put it into a savings account, setting it aside for a rainy day? Or do you invest it, allowing for it to grow? This is a tough decision with a number of factors to consider, and it’s typically best to make this decision in conjunction with your property management company.
If your HOA is in the Carolinas, we welcome you to contact Kuester Management Group to discuss this matter in greater detail. We’re a trusted provider of HOA Management in Charlotte NC, Huntersville NC, Myrtle Beach SC, and HOA Management in Fort Mill SC.
Understanding the Purpose of the Reserve Fund
First and foremost, it may be helpful to have a little background information. A reserve fund denotes money that’s set apart from the regular operating budget, set aside to handle major or unexpected expenses that might arise. Some common examples include replacing the roof of the HOA clubhouse, having new sidewalks put in, or replacing a fence following a storm or accident.
Your state laws, along with the bylaws of your organization, may require you to maintain a reserve fund, and/or to conduct a reserve study regularly, ensuring you have sufficient assets for any likely expenses that could soon arise. It’s also worth noting that some laws or governing documents may restrict your ability to invest the reserve fund in stocks, bonds, or other asset types, which could make this whole issue moot.
Investing Reserve Funds: Pros and Cons
When it comes to whether to choose a high yield investment or simply keep the reserve fund in a bank account, there are some pretty stark pros and cons.
The main reason who some Boards choose to invest is because it allows them to passively grow their money, multiplying the assets that the HOA has at its disposal. Most HOAs could use this extra money, and a traditional bank account won’t offer much in the way of interest.
The downside is that there are predetermined times associated with any investment, which means you have to keep the money invested to a certain point… meaning that, should a real emergency arise, the HOA won’t have those funds readily available. In worst-case scenarios, this might force the association to take out a loan or a line of credit.
To summarize, the debate over whether or not to invest these funds comes down to a desire to grow the investment versus a desire to maintain liquidity.
To Invest or Not to Invest: Factors to Consider
As your HOA Board wrestles with whether or not they should invest their reserve funds, there are a few important factors to consider.
- What does the law say? As we mentioned, there may be some legal limits on how your HOA can invest its reserve funds. For example, you may find that your state only allows HOA monies to be invested in government-backed investments, including treasuries and CDs (certificates of deposit), among other examples.
- What’s in the best financial interest of the HOA? Your Board has a fiduciary responsibility to homeowners, which means it’s critical to be attentive to market conditions and to make a wise decision, taking into account risks as well as rate of return. Your HOA may decide it’s best to invest in something like a CD, which will yield some interest while also protecting your principle.
- What do your bylaws say? Your HOA governing documents may provide some parameters or guardrails for investing HOA funds. It’s pretty common for bylaws to denote that reserve funds can be invested just so long as the principle itself isn’t touched… but of course, you’ll always want to double check.
- How much do you understand investing? Do any of your Board members have real knowledge or expertise concerning investment? If not, you may wish to seek input from an investment adviser before you proceed. Or, you might simply reach out to your property management company to see what type of insight they can offer.
Creating an Investment Policy for Your HOA
Before you start sinking HOA funds into an investment portfolio, it’s helpful to have a basic strategy in place. Here are a few parameters that we’d recommend for any HOA investment policy.
- Safety and Risk Management. First and foremost, your investment policy should provide some guardrails to help you ensure the safety of your HOA’s assets. This might mean choosing only federally-insured investments, it might mean choosing only investments that protect your principal, or it might mean providing a simple hierarchy of investment options. As a rule of thumb, CDs and treasury bills are usually the safest bets, while more volatile options include mutual funds, municipal bonds, and non-government bonds.
- Liquidity. Also consider options for ensuring that your HOA always has at least some money at the ready, even if it’s just limiting the percentage of your reserve fund that can be invested, or prohibiting any long-term investments. Remember that if you lose liquidity, you may have no choice but to impose special assessments on your homeowners.
- Costs. Finally, remember that some investment opportunities may have fees or costs associated, especially if you work through a broker. Your policies may want to specify what level of investment cost is allowable.
Getting Started with an Investment
Before you implement your investment strategy, there are a few more preparatory steps you may want to take. Our general guidelines include:
- Know how much money you actually have available to invest, which might mean conducting a reserve study if you haven’t conducted one pretty recently.
- Do your due diligence when it comes to researching and comparing financial institutions, understanding that not all of them are created equal.
- Talk with your in-house experts about any likely or known maintenance needs for the coming year, ensuring you maintain sufficient liquidity.
Again, with specific questions or concerns, don’t hesitate to contact your community association management team.
Frequently Asked Questions
Can a reserve fund be invested?
It depends on any limitations imposed by the state or by your HOA’s governing documents.
How much should you have in a reserve fund?
As a rule of thumb, we would recommend having 70 percent or higher of the property’s calculated deterioration.
Are HOA reserve funds taxable?
Reserve funds are not considered to be taxable income. However, using them to pay for operating expenses automatically makes them taxable.