Hoa Fund Investment Strategies: A Guide To Smart Investing

HOA reserve funds are savings put aside by an HOA board for unexpected expenses, such as repairs or replacements of worn-out facilities, that are not covered by insurance. The successful running of an association depends on how these funds are managed. While some opt for safe options like CDs and money market accounts, others argue that low-interest rates and inflation mean these reserves will lose value over time. This has prompted discussions on whether HOA funds should be invested in stocks or mutual funds instead. However, it's important to remember that HOA directors are fiduciaries and could be held liable for any losses due to investment downturns. To make informed decisions, HOA boards should consult investment advisors and develop a written investment policy, balancing risk with potential yield.

Understand the rules of investment

Understanding the rules of investment is a crucial first step in crafting a reserve fund policy. This involves checking your state laws and governing documents to determine the permitted investment avenues for your reserve funds. While some states, like Florida, predominantly invest reserve funds in basic, safe vehicles such as interest-bearing or investment accounts, others allow for a broader range of investment options. For instance, in Utah, reserve funds are defined as money allocated for repairing, replacing, or restoring common areas with a useful life of more than three years and less than 30 years.

It is essential to review your governing documents to ascertain whether they outline an investment strategy. If they do, allocate time during your board meetings to thoroughly review and discuss this strategy, making any necessary amendments to ensure compliance. Conversely, if your governing documents lack an investment strategy, it is the board's responsibility to create one. This investment policy should encompass crucial elements such as how funds will be invested, insurance requirements, and the designated decision-makers for investments.

State laws play a pivotal role in shaping the investment landscape for HOA reserve funds. For instance, the Davis-Stirling Act mandates that managers deposit HOA funds in federally insured accounts. As of 2022, AB 1101 further prohibits investing HOA funds in stocks or other high-risk investment options. While there may be no explicit restrictions on the board's investment decisions, it is imperative to exercise caution and seek investment advice to develop a written investment policy, thus safeguarding the HOA's financial future.

When considering investment choices, it is vital to comprehend the implications of various options. For example, investing solely in FDIC-insured money market accounts or CDs may not yield optimal returns, and alternative investment strategies, such as longer-term federal bonds, could be explored. However, it is important to remember that each investment option comes with its own set of considerations and potential challenges.

In conclusion, understanding the rules of investment for HOA funds involves a thorough examination of state laws, governing documents, and the creation of a robust investment policy. By staying informed and seeking expert advice, HOA boards can make prudent investment decisions that safeguard the community's financial future.

Set goals for investing

Setting clear goals is a crucial step in investing HOA reserve funds. This involves understanding the purpose of the funds, the level of risk that can be taken, and the desired returns. Here are some key considerations for setting investment goals:

Protect the Principal by Reducing Risk

The first goal should be to protect the principal amount of the reserve funds. This means keeping the risk factor in mind and opting for lower-risk investments to safeguard the original investment. Insurance and low-risk investment funds are recommended to ensure the safety of the reserve funds. Playing the stock market or choosing other risky investment options can lead to significant losses and is often against the fiduciary duty of board members.

Ensure a Reasonable Return on Investment

While protecting the principal is essential, it's not enough just to save for future expenses. Inflation will impact the purchasing power of the funds over time, so the investment returns should ideally account for this. For example, if inflation is at 2.5% but the yield on bank savings is only 0.1%, the difference will need to be covered by the homeowners. Therefore, finding investments with reasonable returns is crucial to maintain the value of the reserve funds.

Availability and Accessibility of Funds

The availability and accessibility of the funds are also important considerations. Investing in long-term bonds or similar instruments might offer higher returns, but there could be penalties for early withdrawal, and the funds might not be available when needed for repairs or replacements. Thus, the investment strategy should consider the timeline of expected expenses and ensure that funds are accessible without incurring additional costs or penalties.

Comply with Legal and Governing Requirements

It is vital to understand the legal and governing requirements regarding HOA reserve funds. State laws and community guidelines may dictate how reserve funds can be invested. For example, some states require reserve funds to be liquid and easily accessible, limiting the types of investments allowed. It is essential to consult these guidelines to ensure that any investment strategy complies with the relevant laws and governing documents.

Consult Experts and Develop a Written Policy

Before finalizing the investment goals, it is advisable to consult financial experts, such as CPAs, financial advisors, or community association management teams. Their expertise can help navigate the complex world of investments and ensure that the investment strategy aligns with the specific needs and constraints of the HOA. Additionally, developing a written investment policy is crucial. This policy should outline the investment goals, risk tolerance, decision-making processes, and any other relevant guidelines to provide a clear direction for current and future board members.

Consult financial advisors

Consulting financial advisors is a crucial step when making investment decisions for your HOA reserve funds. Here are some detailed instructions and considerations to keep in mind:

• Understand the Role of Financial Advisors: Financial advisors are experts in investment strategies and can guide your HOA board to make prudent and informed decisions. They will help you navigate the complex world of investments, providing valuable insights and recommendations. Their role is to ensure that your reserve funds are managed effectively, balancing risk and return to meet your HOA's financial goals.
• Select Reputable and Experienced Advisors: When choosing financial advisors, look for individuals or firms with a strong reputation and extensive experience in the field. They should have a proven track record of success in managing investments for HOA organizations or similar entities. Ensure that your advisors hold relevant qualifications and are licensed to provide investment advice.
• Diversify Your Advisory Team: Consider assembling a team of advisors from different backgrounds and areas of expertise. This diversity brings a range of perspectives and ensures that your HOA has access to a comprehensive set of skills. Your team may include a CPA, a reserve advisor, a financial advisor or broker, and a community association management professional.
• Provide Relevant Information: Before seeking advice, ensure that your financial advisors have all the information they need to understand your HOA's financial situation. This includes providing them with your reserve study, financial statements, and any other relevant documents. Be transparent about your current investments, cash flow, and future financial goals.
• Involve Advisors in Decision-Making: Invite your financial advisors to participate in HOA board meetings where investment decisions are discussed. This allows for a collaborative environment in which advisors can provide real-time insights and answer questions. Ensure that the entire board is involved in the decision-making process, rather than leaving it to a single member or the treasurer.
• Consider Risk Tolerance and Goals: Work with your advisors to establish a clear understanding of your HOA's risk tolerance and investment goals. Define the level of risk your organization is comfortable with and communicate this to your advisors. Additionally, set specific financial goals, such as target returns or the preservation of capital, to guide your investment strategy.
• Regularly Review and Adjust: Investing is a dynamic process, and your HOA's financial situation may change over time. Work closely with your advisors to regularly review and adjust your investment strategy as needed. Stay updated with market trends and be prepared to adapt your approach to seize opportunities or mitigate potential risks.
• Understand Fees and Compensation: Be clear about the fees and compensation structure for your financial advisors. Understand any potential conflicts of interest and ensure that their recommendations are aligned with your HOA's best interests. Ask for full transparency regarding costs, and make sure they are reasonable and provide value for your organization.
• Document and Implement Advice: Ensure that the advice provided by your financial advisors is properly documented and archived. This helps maintain continuity and provides a reference point for future decisions. Once a strategy is agreed upon, work with your advisors to implement it effectively, including setting up the necessary accounts and monitoring investments.
• Monitor Performance and Seek Ongoing Advice: Regularly meet with your financial advisors to review the performance of your investments. Monitor whether your investments are meeting expectations and make adjustments as recommended by your advisors. Stay in close communication to seek their ongoing advice, especially when market conditions change or new investment opportunities arise.

By following these instructions and maintaining a strong relationship with qualified financial advisors, your HOA can make well-informed investment decisions that balance risk and return. Remember that the ultimate responsibility for the management of reserve funds lies with the HOA board, so be diligent in overseeing the implementation of any investment strategies.

Understand the risks

Investing HOA funds is not without its risks. HOA directors are fiduciaries and can be held liable for any losses incurred by the principal due to a downturn in investments. Therefore, it is crucial to understand the risks associated with different investment options. While investing in stocks or mutual funds may offer higher potential returns, they also carry a higher risk of loss. On the other hand, traditional options like CDs and money market accounts may be safer, but with low-interest rates, they can lead to a loss in value over time due to inflation.

State laws and governing documents play a crucial role in defining the investment options for HOA funds. Some states, like Oregon, restrict HOAs from investing in municipalities, mutual funds, or indirect investments, while others, like Utah, allow reserve funds to be 'prudently invested' without specifying the investment type. It is essential to understand the legal framework and any restrictions imposed by your state to make informed investment decisions.

Another risk to consider is the impact of inflation on the buying power of reserve funds. As Bob Diamond, a partner at the law firm Reed Smith, points out, investing in low-interest vehicles like U.S. Treasury bonds may not preserve the buying power of the reserves if the inflation rate in construction costs is higher. In such cases, investing a portion of the funds in equities or higher-yield options may be a strategy to maintain the purchasing power of the reserves over time. However, this approach carries higher risks and should be carefully considered.

The availability and accessibility of funds are also crucial factors to consider. Investing in long-term bonds may offer higher returns, but it could result in a lack of liquidity if funds are needed for unexpected repairs or replacements. It is important to strike a balance between investing for the long term and maintaining sufficient liquidity to cover short-term expenses.

Lastly, it is essential to seek expert advice. Consult community association management teams, accounting teams, CPAs, reserve advisors, and financial advisors to gain insights into different investment options and their associated risks. By understanding the risks involved and making informed decisions, HOA boards can effectively safeguard the financial future of their communities.

Know when to use your reserves

Knowing when to use your reserves is critical to the successful running of your association. It is imperative to understand that reserve funds are not for the maintenance of community properties but are instead for unforeseen occurrences, such as repairing extreme damage or replacing worn-out facilities. If you use the funds for maintenance or other unnecessary expenditures, you are misusing the funds and doing a disservice to your association and its members.

To determine whether you should use your reserve funds, ask yourself the following questions:

• Is this a recurring expense? If it is an expense that will come up again in the near future, it is likely an operating expense that should be covered by the HOA's operating fund.
• Is this a capital improvement? If you are adding something new to the community, it is considered a capital improvement, and reserves should not be used to pay for it. Remember that reserves are only for replacements, repairs, and unforeseen expenditures.

By understanding when to use your reserves, you can ensure the financial stability and longevity of your association and avoid legal consequences associated with the misuse of funds.

In addition to knowing when to use your reserves, it is crucial to maintain the correct reserve level. Assess the remaining life of the association's major capital systems and estimate the future cost of repairs or replacements. This will help you determine how much money you need to save annually to cover these expenses. Conducting a reserve study can also provide a comprehensive understanding of your reserve's financial health.

By following these guidelines, you can effectively manage your HOA reserve funds, ensuring they are used appropriately and in the best interests of the community.

Frequently asked questions