Invasion of the Interest Rate Slashers - Protecting your Investments

Invasion of the Interest Rate Slashers - Protecting your Investments

Tue, 5 Nov, 2013 at 16:07
Printer-friendly versionPrinter-friendly version

Its 2013 and we are still in one of the lowest rate environments that the country has seen for a very long time…its getting a little better, but there is still a long way to go for the rates to get back to the “glory days”.  Of course, if your association needs to borrow it’s a good place to be, but if your association has done its job over the years and has reserved money for future inevitable capital improvement expenses, its not so good.  Just because the rates are low everywhere, doesn’t mean that you should just let the dollars ride, roll over or sit dormant.  While we cannot control the rates that the Federal Reserve has set, we can devote some time to looking at the big picture and reviewing the small details.  Now more than ever it is important to get back to the basics and Take Charge!!

The Basics

Among the many functions of a Board for the association is a fiduciary responsibility to the owners, they must strengthen the value of the association.  These duties are generally well laid out in the Declarations of Covenants, Conditions and Restrictions for the association and include everything from enforcing the rules, executing contracts for services that the association uses, keeping minutes during Board meetings and financial management.  Financial management can be a job that is shared between the management company and the Board, or it can be done solely by the Board.  In either case, it will include responsibilities such as assessing and collecting the monthly dues, providing an annual budget to allow the property to meet its financial obligations and to ensure sound financial decisions are made on behalf of all the owners.  Setting the budget and determining the monthly dues can be a time consuming process and should include not only the expenditures, but also a reserve allowance for future expenses.  Budgeting for the future expenses (ie. big ticket items) should be based on the reserve study.  The reserve study should be reviewed annually and should go out at least 5 years.  Not doing this review will risk home values decreasing (more on this below).  On the flip side, if you follow the reserve study, it will result in a healthy savings for the association that can then be properly invested until needed.   In addition, it will provide a cushion for emergencies. 



Reserve Study-Why is this important? 


A reserve study will provide an estimate of the remaining useful life and replacement cost of the common elements of the property.  An independent reserve study done properly will help the association determine how much money needs to be invested and what the monies are being saved for.  This study then becomes the guide for investing.  How long to invest in a Certificate of Deposit is difficult to determine without this guide.   For instance, if funds are set aside for a roof project that will not be happening for  3-5 years, the association may consider taking advantage of a shorter term CD special for a portion, but then also staggering your maturities for the rest of the money.  This will protect the associations money from large market swings and once the association averages the yields, they may find that this will provide them with the largest interest income over time. 



Investment Policy for Reserves-Does your association have one in place? 


Many associations already have an Investment Policy in place, if your association doesn’t have one, then they should consider adopting one.  It doesn’t have to be anything elaborate, but it should include a few objectives like:  Ensuring no risk of loss of principal, keeping some reserves liquid for short term needs and achieving the highest long term investment performance.  The reserves will grow in two ways, by the monthly contributions from the portion of the dues collected and from interest earnings.  Of course, the more interest earned, the less contribution will be needed from the homeowners.  In order to meet the above objectives, the investments can include savings accounts, money market accounts, certificates of deposit (all FDIC insured), and treasury bills, notes or bonds.  The bank investments need to remain under the $250,000 FDIC limit for the maximum FDIC protection to the association.  When reviewing the investments for the association, it is important to stagger the maturities of the certificates of deposits (commonly called “laddering”) and be sure that about twenty percent of the reserves are in a liquid account like a savings or money market account.  Money market or savings accounts provide instant access to funds for unexpected expenses and the association won’t be subject to any early withdrawal penalties if funds are needed in the short term.  As the association decides what terms will be best for certificates of deposit, they should consult the budget and reserve study for clues.  Typically, shorter term certificates will pay lower rates and longer term certificates will pay higher rates, but the overall average yield of all your investments is what matters.  Maximizing this average yield to its highest potential while staying true to your investment policy is the responsibility of the Treasurer or Board. 

Keeping up with Inflation

So, herein lies the problem, the rates are all low…now what do we do?  Raising assessments is not very popular, but could be the best for the community at large to build reserves that are losing value based on the inflation value of the deposits. Rates this low cannot make up for the rate of inflation.  In fact, it’s going to be quite a while before the economy recovers enough to help.  The budget needs to be adjusted to reflect this lower rate environment, if it has not already been.  Most importantly, don’t sacrifice the value and health of the association and make any risky investment decisions.  Always keep to the set investment policy plan, laddering Certificate of deposit maturities and ensuring that all the investments are fully protected from loss of principal. 

Keeping ahead

Associations are a business and should be thought of as such.  Looking for ways to decrease costs and increase revenues are common ways for a business to survive.  Yes, the rates are low now, but they won’t always be low.  Applying the same principals during prosperous times as well as lean will protect the association from risk, loss of value and potential special assessments. 

By: Pamela Mullen, Senior Vice President at Wintrust Community Advantage, a Wintrust Company