Money Market, Bonds and CD Ladders, Oh My! Understanding Investment Options for your Utah Community Association’s Reserves

What Should You Include in Your Investment Portfolio?

In part one of this series, we discussed the goals for  your investment portfolio, as  well as the legal and governmental rules guiding investments. Now let’s get into the meat of the matter. What do you actually invest in, and how should your investment strategy work?

While some standard investment options are simply considered too high of a risk to warrant investing association funds, there are still several options available to you that work well for community associations. Bank savings accounts, money market deposit accounts, US Treasuries (bills, notes and bonds) and Certificates of Deposit are all insured or guaranteed and are considered low risk options acceptable for reserve fund investments. Other options, such as mortgage backed securities, money market funds, mutual funds, corporate bonds, and stocks are too high risk and would not be prudent investments…

A Quick Word on Taxes

Conservative investing is about more than just the amount you can make on the investment itself. Most community associations are not for profit corporations, and thus income gained through assessments may be tax exempt. Be wary of profits gained through investments that are considered non-exempt income (and thus fully taxable). If your investment profits exceed 10% of your association’s budgeted income, you may be subject to unexpected taxes which could counter the profits you made from the investments.

Investment Options: The Good, The Bad and the Ugly

Remember, you are looking at three key factors: Risk, to protect the principal, Yield, for return on your investment, and liquidity, for the availability of and accessibility to the funds when needed.

  • Bank Savings Accounts
    Not recommended for community associations
    The most basic form of investing outside of a ceramic pig, bank savings accounts are sufficiently low risk for community association funds, being insured by the FDIC for up to $250k, but they lack the yield to make them a viable option. Typical savings account yields are less than .1%, and with bank fees, are often even less.
  • Money Market Deposit Accounts
    Recommended for community associations
    A short step up from bank savings accounts are money market deposit accounts (not to be confused with money market funds.) These accounts, also insured up to $250k by the FDIC, carry minimum investment amounts and have limits on the frequency with which you can access your funds, but they pay slightly better than a standard savings account, at around .25% Avg yield.
  • US Treasuries
    Recommended for community associations
    Collectively called treasuries, all US bonds, notes and bills are guaranteed by the US government. Treasuries have a low liquidity because the money is unavailable until it matures, unless you sell it at auction through a broker. However, treasuries have the advantage of not being taxed at the local and state level.

    • Treasury Bills (aka T-Bills)
      These short-term investments mature in less than a year. The bills are bought at auction for less than face value, then you receive full value when it matures. (For example, a 180-day valued at $1,000 auctions for $995. When the bill matures, you are paid the full $1,000.) T-bills average a yield of around 1.3%.
    • Treasury Notes (aka T-Notes, bonds, war bonds)
      Notes sell for a certain number of years (2 to 10) at the face value rate (a $10k note would cost $10k to acquire.) Semiannually, interest will be paid out on the value of the note based on the national interest rates. This fluctuates, so the yield amount can vary but on average, treasury notes yield around 2.3%. When notes mature, the full principal amount will be returned.
    • Treasury Bonds (aka T-Bonds, Long Bonds)
      Similar to notes, bonds differ in the length of time until they mature: 20 or 30 years. In general, long bonds provide a higher yield, averaging around 2.8%.
  • Certificates of Deposit (CDs)
    Recommended for community associations
    Investing in a certificate of deposit is essentially buying into the future success of a bank. As CDs are insured up to $250k by the FDIC, CDs offer a very low risk, for a very reasonable reward. Of all the options presented above, CDs are the most commonly used in community association reserve investment portfolios.CDs are purchased in time increments from 3 months to 5 years. CDs often have minimum purchase amounts (such as $1,000 or $10,000), and yields are often tied to both the length of time to maturity, and the amount level of the CD purchased. Unlike Treasuries, where the yield can vary with interest rates, CDs have a fixed yield amount when you purchase them. For that reason, it is important to shop CD rates before you buy to find the best option for you. Because CDs have very limited liquidity, with fees and penalties for cashing them in early, many community associations opt to create a CD ladder structure to ensure that some amount of the principal is available at regular intervals.

  • Money Market Funds
    Not recommended for community associations
    Some financial advisors may attempt to steer your community association toward money market funds. Do not confuse these with money market deposit accounts! A money market fund is a group portfolio consisting of CDs, Treasury Bills and other low-risk investments. Yield is generally in the low single digits. Even though money market funds focus on secured investments, the fund itself is NOT insured, meaning that investors can, and have, lost it all with this type of investment. Additionally, fees & taxes apply to money market funds, and may even outpace yield.
  • Mutual Funds
    Not recommended for community associations
    Leveraging the buying power of a large group of people, Mutual Funds offer a group portfolio consisting of stocks, bonds and other securities. Yields vary but tend to fall between 5-10% annually. Fees and Taxes apply. Mutual Funds are not insured or otherwise  guaranteed.
  • Stock Market and Other Securities
    Not recommended for community associations
    Any other non-insured investment opportunities, including mortgage backed securities, corporate bonds, stock exchanges, or foreign government bonds and certificates are considered too high of a risk to invest community association reserve funds.Be wary of brokers pushing these options as safe due to SIPC insurance. This insurance does protect investors from bad behavior on the broker’s part, but it does not insure your principal against a market crash, burst bubble, or other financial collapse.

Laddering Investments

The more up to date your reserve study, the more predictable you can be with your investment strategy. If you can bank on the fact that you will not need to repave the roads for another 6 years, you can afford to put those funds into a 5 year CD or Treasury Note, knowing that the money will be available when you need it. If your reserve study is not up to date, and erosion breaks down the roads faster than predicted, you may find yourself needing those funds in 3 years, but they are locked in for another 2.

Many community associations resolve this issue by laddering their investment portfolio. With laddering, the liquidity of your principal is less important because investments are coming to maturity on a regular basis. If you need access to funds quickly, you know there will be a CD or Treasury maturing in the near future that you can access, and if you don’t need it, you can simply reinvest that one, and pick up the next one that matures.

How to Set Up A Reserve Investment Ladder

Laddering works like this: Instead of investing the whole lump sum of your reserves into one security, you break it into multiple smaller chunks. Diversify the chunks into various termed investments, such as 1-year CDs, 2-Year Notes, 5-Year CDs, 10-Year Notes, etc. As each investment matures, re-evaluate the funds, and either spend the principal if needed, or reinvest it in a higher ladder rung (ex, use the yield from your 1 year CD plus the principal to reinvest it as a 2 year CD.)

Tie the timelines when investments will mature to the major replacement timelines in your reserve study. If the clubhouse roof will need to be replaced in 6 months, for example, make sure that you have a CD or treasury that will mature in time for you to make payments to your roofing contractor.

Throughout the year, as the association collects assessments, invest the amount earmarked for reserves into your money market deposit account. Then when a CD or Treasury matures, you can use these funds to add to the base of that investment so you can move it up the ladder or add new shorter-term investments at the bottom.

Benefits of Laddering Reserve Fund Investments

The added benefit of this type of investment strategy is that it magnifies over time. As long as you continue moving your investments up the ladder, and adding new ones at the bottom, your returns will grow, allowing you to keep assessments low by funding increases out of your investments instead.

With this strategy, you should be able to craft a strong, diverse, sustaining investment portfolio. But you won’t be on the board forever. An investment policy is an amendment to your governing documents that will define how future boards will invest the association’s reserve funds. We’ll go into that in the final part of this ongoing series.

Need Help with Your Strategy?

Are you a Utah Condo or HOA looking for a management company that can help you implement a sound investment strategy for your reserve funds to safeguard your community association’s future? Take advantage of this free strategic evaluation to see if HOA Strategies is a good fit for your community.