It’s Time to Actively Manage Reserve Fund Investments

It didn’t used to matter too much if you reviewed your clients’ reserve fund investments regularly. Why? Because the choices didn’t change, much. Yes, you could have possibly cashed out a CD paying 1/2 of a percent return in favor of one paying 3/4 of a percent. But to do so mid term, most likely didn’t pencil out when calculating in the early cash out penalty. Even if it did, it was not by much, so we waited until maturity date to assess next steps.

Let’s look at an example. If you had two years left on a $100,000 CD paying 1/2% and could get a new 2-year CD at 3/4%, over those two years the change would offer a net gain of $250 in interest. But let’s presume that the early cash out penalty is 6 months’ worth of interest (a fairly typical penalty provision), your penalties would total $500. Not a good deal, netting a loss of $250. Now let’s look at a second example. Let’s presume the same CD options as the first example except with three years instead of two. And let’s presume the early cash out penalty rather than 6 months, to be only 3 months’ worth of interest (which is an uncommonly low penalty). In this scenario an early cash out would have gained $375 in marginal return and your penalty would have been $250. So yes, in this case (which is a fairly extreme one) you would have gained $125 for your client. But again, this scenario is an outlier and seldom would you have found that much of a gain. If for instance 5% of your 100 client CD’s offered such a gain, that means you would have been doing quite a bit of work to save an average of about $6 per CD. So, it really made little sense to manage hundreds of CD’s on a monthly basis, in return for so little gain. It made more sense to let the banks manage them via maturity date tracking and notification of same. Or perhaps for your company to simply track them and address them based on maturity dates rather than on an ongoing basis. So you simply managed these CD’s when they matured. This was a reasonable process and was really the expectation.

That was then and now is now. Now we are in a major transition period for all things financial. So that CD rate swing can now be a lot more dramatic. The difference between currently active CD’s which were purchased a year or two ago and those available now or in the near future, is much greater. Instead of something along the lines of 1/4 percent difference, there now could be 2% or 3% or more! So the stakes could easily be 10 times those mentioned in the scenarios above. The $125 could now be $1,125 or so. Sure you can still sit by and wait for a CD to mature in a few years, but you will likely suffer some backlash when a board member or homeowner wonders (almost always out loud and often very loudly), “why the h*** are we sitting on a half million dollars returning only 1/2 percent when we can be getting 4%?! With the current upswing in CD rates, the price of early termination of a CD is minor compared to the amount to be gained by paying the early termination penalty in favor of a higher return. There are two forces that make that so. One is, since most penalties are measured in terms of paying a portion of interest earned, at the old rate, well, at 1/2 percent the basis of the penalty is very small. And of course the other is that the delta in the return on CD’s from a while ago to the return on CD’s today is, not so small. In fact it can be quite large, particularly if applied to the large sums of money held in capital reserve accounts by homeowner associations and even more so by condominium associations. Yes it does take a bit of work but you will likely feel the wrath of not doing the work early on, if board members or homeowners wake up to the fact before you do. Oh, and of course, there is a good chance that will occur because, well, they have you outnumbered. You can try to simply stay low and keep your head down, but it is usually better to keep your head and guard up.

James Comin Solutions is building a great tool to help you, and more! With our tool, you enter in a community’s existing CD’s held by the client, then populate a table of current CD options, and our calculator will offer a plan to maximize the return on the association’s funds while keeping them liquid only to the point necessary to meet reserve expenditure obligations as they appear in future years. That’s right, “just-in-time” liquidation of your investments to correlate with the expenditure timing set forth in your reserve study. How does it know when the money is needed? Well, we can’t tell you all of our secrets. Stay tuned though, as we should have this product available sometime in the third quarter of 2022.