Hoa Reserve Fund Investment Strategies: Where To Invest For Growth

Investing HOA reserve funds is a complex decision that can impact the financial growth of an association. While investing can be a great way to grow the funds, it's important to carefully consider the risks involved. The funds are intended for emergency repairs and capital improvements beyond the scope of the normal operating budget, so maintaining liquidity is crucial. Before investing, it's essential to understand the relevant state laws, the fiduciary duty to members, and the investment knowledge of board members. A well-informed decision, made in consultation with experts, can help ensure the funds are managed effectively for the benefit of the community.

State and federal laws

State Laws:

State laws vary, and it's important to consult the specific regulations in your state. For example, in California, the Civil Code Section 5515 mandates that HOA boards exercise "prudent fiscal management" regarding reserve funds, which includes making prudent investment choices. Similarly, Oregon has laws restricting associations to government-insured investments like treasuries and certificates of deposit. These state-specific regulations are essential to understand when making investment decisions.

Fiduciary Duty:

HOA board members have a fiduciary duty to act in the best interests of the community. This duty extends to the management of reserve funds. It is crucial to balance the potential for investment growth with the need to safeguard the community's funds. The board must ensure that reserve funds are available when needed for repairs, maintenance, or emergencies.

Governing Documents and Bylaws:

The HOA's governing documents and bylaws may include policies and guidelines regarding reserve fund investments. These documents often allow the board to invest as long as the principal amount remains untouched. However, it is essential to carefully review and understand these policies to ensure compliance and make informed decisions.

Investment Restrictions:

Some state laws and governing documents may restrict the types of investments that HOAs can make with their reserve funds. For example, certain states may limit investments to government-backed options like treasuries and certificates of deposit. It is crucial to be aware of any such restrictions before making investment decisions.

Investment Policy Creation:

When creating an investment policy for HOA reserve funds, safety and risk management should be paramount. Federally insured investments, such as FDIC-insured accounts, treasury bills, and certificates of deposit (CDs), are generally considered the safest options. It is also crucial to maintain liquidity by avoiding long-term investments that may restrict access to funds when needed. Additionally, consider the costs associated with different investment opportunities, as some may involve fees or broker expenses.

Fiduciary duty

When it comes to investing HOA reserve funds, there are several factors to consider. One of the most important considerations is the board's fiduciary duty to its members. A board member's purpose is to make decisions in the best interest of the community, which includes the management of HOA reserves. This is known as a fiduciary duty.

The fiduciary duty of HOA board members can be broadly categorised into three types: the duty of care, the duty of reasonable inquiry, and the duty of good faith. The duty of care requires board members to exercise sound business judgment and make reasonable inquiries before investing community funds in a project. The duty of reasonable inquiry means that board members must conduct a reasonable amount of research and due diligence before making financial decisions. The duty of good faith, also known as the duty of loyalty, requires board members to act in good faith and avoid self-dealing, which is making decisions that benefit themselves instead of the community.

When investing HOA reserve funds, the board must carefully consider the risks and potential returns. While investing can lead to financial growth, it also carries the risk of losing funds or sacrificing liquidity. Therefore, the board must balance the potential for growth with the need to safeguard the community's funds. This involves considering state laws, governing documents, and the current economic climate to make informed and prudent decisions.

In summary, the HOA board has a fiduciary duty to its members when managing and investing reserve funds. This duty encompasses making decisions that protect the community's funds, conducting reasonable inquiries, and acting in good faith. By fulfilling their fiduciary duty, the board can ensure that the reserve funds are managed effectively and in the best interest of the community.

Investment policy

The HOA board has a duty to safeguard the community's funds and make decisions in the best interest of the community. Therefore, the investment policy for reserve funds should prioritise safety, liquidity, and yield, in that order.

Safety

The HOA's reserves are integral to the continued operation of the association. Therefore, capital preservation and the avoidance of loss are key. To safeguard the HOA reserve funds, only FDIC-insured accounts or investments should be considered. Bank savings accounts, treasury bills, and certificates of deposit (CDs) are usually the safest options.

Liquidity

Reserve funds should be readily available to cover the cost of major replacements, repairs, and maintenance. The association must be able to convert reserve investments into cash as quickly as possible when needed. Therefore, the policy should emphasise the importance of liquidity and prohibit any long-term investments that would lock up funds.

Yield

While yield is important, it is a lower priority than safety and liquidity. The investment policy should aim for a reasonable return, understanding that lower-risk investments like bank savings accounts offer very low yields. Certificates of deposit are a common choice for associations as they offer fair rewards with low risk.

State and Governing Laws

The investment policy should comply with state laws and the HOA's governing documents, which may include restrictions on the types of investments permitted. For example, some states may limit HOA investments to government-insured investments such as treasuries and CDs.

Expert Advice

The HOA board should consult with experts, such as an investment advisor or financial advisor, to ensure that the investment policy is well-informed and aligns with the association's financial goals and risk tolerance.

Regular Review

The investment policy should be reviewed regularly, at least annually, to ensure it remains relevant and effective in safeguarding the association's assets and meeting its financial objectives.

Board member knowledge

As a board member, it is your responsibility to protect the assets of your association. This means only investing in safe, low-risk options such as FDIC-insured money market accounts and certificates of deposit (CDs). It is also important to avoid risky investment vehicles like mutual funds or bonds, as these can lead to consequences even without the intent to do harm. For instance, if one of those investments falters, you may not have the necessary reserve funds to complete a planned maintenance project.

Additionally, if a board member invests in a risky vehicle, there may be legal consequences. If reserves are invested improperly, a resident could sue the board for breaching their fiduciary duty and putting the funds of the community at risk.

If you or most of your HOA board members do not have a background in investing or finances, you can hire an investment advisor with experience working with HOAs. This is especially helpful if you have large reserves.

It is also important for board members to have a basic understanding of HOA financials. Along with understanding your responsibility as a fiduciary, it’s important to be informed about HOA investments and your financial obligations. Even if you are working with a financial services company, make sure your association is choosing safe and time-tested investments.

Your HOA's investment policy should be laid out in the governing documents. If you have yet to craft one for your HOA, it is imperative to consider the following in order of priority:

• Safety Above All Else: When investing HOA funds, you must put safety above all else. Your HOA’s reserves are integral to the continued operation of your association. Therefore, you must ensure capital preservation and avoid loss. To safeguard your HOA reserve funds, consider only allowing FDIC-insured accounts or investments.
• Liquidity Is a Must: Reserve funds should cover the cost of major replacements, repairs, and maintenance. When the time comes for one of those things, your association must be able to convert your reserve investments into cash as quickly as possible. This is where liquidity plays a role. When creating your policy, make sure to emphasise the importance of liquidity. If your reserves are locked in long-term investments, then you won’t be able to access the money immediately when you need it.
• Consider Yield Last: While some investors might think that the return on investment should be a top priority, the same principle doesn’t apply to associations. Yield is important, but safety and liquidity certainly outweigh it. When crafting your HOA reserve funds investment policy, go with an investment that offers a reasonable return.

Investment options

Before investing HOA reserve funds, it is important to determine whether your HOA's reserve fund is sufficient. Ideally, a reserve fund should be between 70% and 100% funded. This means having enough money to cover all or almost all upcoming replacements and repairs. It is also important to consider the liquidity of the fund, as reserve funds should be readily available when needed.

Once you have ensured that your HOA's reserve fund is adequately funded, you can consider investing the excess funds to generate a return. Here are some investment options for HOA reserve funds:

• U.S. Treasuries: These include Treasury Bills, Notes, and Bonds, which mature in less than a year, between 2 and 10 years, and between 20 to 30 years, respectively. They offer modest yields, but they are not taxed at the state or local level. However, they usually offer low liquidity as they are locked in until maturity.
• Money Market Deposit Accounts: These accounts offer a more generous yield than bank savings accounts but require a minimum investment amount. They also have limits on accessibility, and the FDIC insures them for up to $250,000.
• Certificates of Deposit (CDs): CDs are considered safe investments that offer fair rewards. They are purchased for a minimum amount and in time increments ranging from 3 months to 5 years. The yield amount remains fixed, so it is important to shop around for the best rates. CDs offer low liquidity, and early withdrawal typically incurs a penalty. However, investing in a CD ladder structure allows for the withdrawal of principal at regular intervals.
• Bonds and Mutual Funds: These investment options may be available for HOA reserve funds, depending on state regulations and the HOA's investment policy. Bonds can be a good option for long-term investments, while mutual funds offer higher risks and potential rewards.
• Money Market Funds: While money market funds are not typically recommended due to their risk level, they can provide higher returns than some other investment options.
• Stocks: Investing HOA reserve funds in stocks is generally not recommended due to the high level of risk involved.

It is important to note that the availability and suitability of these investment options may vary depending on state laws, the HOA's governing documents, and the advice of financial professionals. Additionally, it is crucial to prioritize safety and liquidity when investing HOA reserve funds to ensure the protection of the HOA's assets and the ability to cover emergency expenses.

Frequently asked questions