How can the association maximize its return on reserve funds (money set aside for major repairs and replacements)? The starting point is a Reserve Study. A Reserve Study allows the Board to realistically anticipate its reserve expenses 5-30 years into the future. If your Board has wisely invested in a Reserve Study, the next step is to prudently invest the money while it waits to be used.

All too often, reserve funds are deposited into either a money market checking or passbook savings accounts so the funds will be immediately accessible. The rate of return offered in these accounts is often below inflation so to leave it there will erode the value. Your association governing documents [CC&Rs] sometimes restrict reserve investments to those insured by the federal government. If they don't, there is some latitude in directing the funds into higher return investments. Stocks are usually not recommended due to the higher risk involved. Fortunately, there are several investment strategies that can produce higher returns with low risk.

Zero to Five Year Strategy

Staggering or laddering. This strategy allows the association to invest in treasury bills and CDs (certificates of deposit) that mature at different times. Because the investments mature at predictable intervals, the association maintains a steady cash flow and the flexibility to change its investments.

Let's take a look at a CD investment strategy using staggering. In this example, based on the Reserve Study and future cash needs, the Board invests one third of available reserves in a one-year CD. In month four, another third is invested in another one-year CD. In month eight, the remaining third is invested in another one-year CD. In month one of the next year, the first CD matures. If the funds are not needed, the CD is renewed for another year. Or, if only a portion is used, the remainder is rolled over. Additional reserve funds that have been collected by this time can either be added to the CD or another CD can be purchased.

This process can be used with any term CD. It can be adapted so funds mature more or less often, depending on the needs of the association. For example, a new association that won't need funds for some time may be able to consider two or even three year CDs in their portfolio. The longer the term, the higher the yield. This process can be used with other investments or only a portion of the reserve funds. A Reserve Study is an educated estimate and that a contingency or emergency fund of 5-10% should be factored in.

5+ Year Strategy

Asset Allocation. All investments have two components: level of risk and rate of return. The higher the risk, the higher the return...the lower the risk, the lower the return. (Risk is measured by volatility or how much a given investment's value fluctuates). Asset Allocation is an investment concept that previously was available only to large institutional investors. It is now available to modest investors due to computer technology. Asset Allocation provides a proven plan to maximize return while maintaining a low level of risk. Under this plan, reserve funds are invested in multiple asset class mutual funds [For example, reserve funds are invested 30% stock funds, 30% bond funds and 40% cash funds] and the performance is monitored. If changes occur in the allocation percentages, the portfolio is rebalanced to bring it back in line. This allows the association to take advantage of a diversified portfolio that can generate a higher rate of return than say, CDs, with no more appreciable risk.

Conclusion. It's time to get off your reserve assets! By using a Reserve Study to develop holding periods and reserve amounts, the association can take advantage of higher return investments with lower risk. Higher reserve growth means the association will be able to reduce fees to its members over the long haul. Lower fees make happier owners and enhance property values.

For more information on this subject, see www.Regenesis.net.

Published: July 14, 1999

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Richard Thompson owns Regenesis, a management consulting company that specializes in condominium and homeowner associations. He is a nationally recognized expert on HOA management issues. Regenesis publishes The Regenesis Report, a monthly newsletter for HOA boards, developers and managers. To subscribe, go to Regenesis.net. He can be contacted by email at .