CDs vs. U.S. Treasuries
What’s Best for Your HOA Reserve Funds?
By Lisa Beaty & John Polovick
For HOAs, financial stability and long-term planning are crucial. Funds often sit idle in low-yield accounts due to a lack of proactive investment plans and challenges from regulations like the Davis-Stirling Act. An effective strategy should prioritize both security and growth. U.S. Treasuries, especially T-Bills, provide excellent liquidity, allowing for quick access to funds. This is crucial for funding emergency projects or complying with California’s SB 326. Investing in T-Bills helps HOAs not only protect their funds, but also may increase yields over other available alternatives. This approach ensures that funds set aside for SB 326 are secure while generating higher returns, balancing reliable income with the immediate liquidity needed for urgent financial needs.
THE APPEAL OF U.S. TREASURIES AND CDS
U.S. Treasuries: Introduced in 1913, U.S. Treasuries are considered one of the safest investments, backed by the "full faith and credit" of the United States. They are ideal for HOA reserve accounts due to their low risk, tax exemptions, and liquidity, often yielding higher tax-equivalent returns compared to CDs.
Certificates of Deposit (CDs): Introduced in 1961, CDs are low-risk investments offered by banks with fixed interest rates. Keeping investments under $250,000 ensures FDIC insurance coverage. They are also a suitable choice for predictable returns and meeting HOA needs.
To keep principal and interest FDIC insured, an HOA should invest no more than $236,686.50 in a 5.5% CD. The correct investment varies with yield, so the financial advisor should calculate this amount for investment each time before purchase.
As of June 10, 2024, the 3-month Treasury and CD rates are higher than longer-term rates, indicating an inverted yield curve. Assessing and investing in accordance with the yield curve is essential for a fiduciary financial advisor managing assets on behalf of an HOA.
A fiduciary financial advisor will consider this and the need for short-term funds, especially for SB 326 projects or special assessment funds. Investing in short-term T-Bills (one week to three months) can safeguard funds and capture the highest yields with liquidity.
For longer-term funds and regular reserve assets that are not immediately needed, a fiduciary financial advisor may recommend longer-term investments to lock in current rates before they potentially decline. This strategy, aligned with the community manager and reserve study, helps meet the HOA’s broader financial needs and goals.
WHEN TO USE EACH INSTRUMENT
Choosing Treasuries or CDs depends on interest rates, tax implications, and HOA needs. Quickly purchasing the right instrument after maturity optimizes returns. This emphasizes the value of working with a financial advisor who can help navigate boards, community managers, and Davis-Stirling requirements. A well-rounded investment strategy for HOA reserve funds should utilize both Treasuries and CDs, leveraging the strengths of each instrument to optimize returns while maintaining liquidity and safety.
As a rule of thumb, in rising rates, T-bills adjust quickly and offer better after-tax yields due to tax exemptions. CDs, with fixed rates, may not be as beneficial. In falling rates, CDs can lock in higher yields. However, an advisor can evaluate the best option for the HOA before each purchase.
CURBING OPPORTUNITY COST
One of the biggest expenses an HOA can incur is the opportunity cost of having idle cash in a reserve account earning only 0.5% when market rates are over 5.5%. For example, $300,000 sitting idle earns just $1,500 annually at 0.5%, but would earn $16,500 at 5.5%. This $15,000 opportunity cost each year highlights the financial advisor’s lack of process and tools to keep funds fully invested, undermining the HOA’s financial health and growth potential.
ASSESSMENT OF RESERVE STUDY
A professional reserve study evaluates the expected lifespan and replacement costs of major components within the community. This helps determine the appropriate investment horizon for the reserve funds, guiding whether short-term Treasuries, medium-term Treasuries, or CDs should be used.
Purchasing Treasuries and CDs with staggered maturities ensures HOA funds are always nearing maturity, allowing for regular reinvestment or withdrawal while maintaining liquidity and optimizing returns.
Market conditions and community needs change, so regular reviews and adjustments are essential. A financial advisor can provide insights and recommendations to keep the strategy aligned with HOA goals and the current economic environment.
BENEFITS OF INVESTING IN TREASURIES FOR HOAs
Safety and Stability: T-bills are very secure, often considered even safer than CDs, backed by the U.S. government’s full faith and credit.
Predictable Returns: Treasuries provide predictable income with regular fixed interest payments, aiding HOA financial planning.
Liquidity: T-bills are easily bought and sold on the open market, ensuring quick access to funds. This liquidity benefits both reserve funds and SB 326 funds. Using very short-term T-bills for SB 326 and longer-term T-bills for reserve funds can provide a powerful combination of accessibility and optimal yields.
Diverse Options: Treasuries offer various maturities and yields, allowing HOAs to diversify with short-term T-bills and medium-term notes. This balances immediate liquidity with long-term growth. Currently, the highest yields for CDs and T-bills are in short-term options of 12 months or less. A financial advisor tailors the portfolio based on the HOA’s reserve study and input from community managers and the board.
THE YIELD SHOWDOWN: 5.5% CD VS. 5.5% TREASURY YIELD SCENARIO
To illustrate strategic investing, consider a $100,000 investment in a 5.5% CD vs. a 5.5% Treasury yield for HOAs in California’s 8.84% state tax bracket. Most HOAs fall into this bracket. T-bills, exempt from state tax, often provide better after-tax returns than CDs. Choosing the correct CD or T-bill based on rates is crucial, and a fiduciary financial advisor can help make the best decision. Consult your CPA for specific tax advice.
CD Investment:
Annual Interest: $5,500
State Income Tax Impact: $486
After-Tax Earnings: $5,014
T-Bill Investment:
Annual Interest: $5,500
State Income Tax Impact: $0
After-Tax Earnings: $5,500
The takeaway? In this example, T-bills can yield a tax-equivalent rate of 6%, surpassing CDs after taxes. Both are subject to federal tax; consult your CPA for personalized advice. This example highlights the potential tax advantages of T-bills over CDs.
Often CDs may offer higher after-tax yields than Treasuries. A financial advisor should calculate the tax-equivalent yield for your HOA before every purchase and can optimize the investment strategy, maximizing yields, ensuring growth. Keeping funds invested, rather than having idle cash, is crucial. Regular monitoring and adjustments are essential for adapting to changing conditions and meeting future needs.
For HOAs, optimizing reserve funds with the right mix of CDs and Treasuries is essential. Short-term T-bills provide the necessary liquidity for special assessment funds, including those allocated for SB 326 compliance. Meanwhile, a combination of short and long-term CDs and Treasuries can help maximize returns for reserve funds. Engaging a fiduciary financial advisor ensures these decisions align with the HOA’s financial goals, offering expert, unbiased guidance without hidden commissions. Regular reviews and proactive investment strategies prevent the costly mistake of idle cash, securing the HOA’s financial health.
Keystone Private Wealth is a registered investment advisory firm that offers patented software for HOA Invest and services. Keystone Private Wealth and its partner Capital CS Group have been helping serve HOA communities for more than 15 years. Keystone Private Wealth offers fiduciary services to HOA communities with their reserve account management.
Disclaimer: The above published rates are as of June 10, 2024. CD and Treasury rates are published weekly through HOA Invest and are subject to change. Rates are based on current market conditions and may fluctuate. Please consult with your financial advisor for the most up-to-date information.
The information in this article is for educational purposes only and should not be deemed investment advice. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital, returns for cash management represent the potential returns of an HOA performing their own investments, they are not net of advisory fees, which would be incurred by utilizing the services of a registered investment adviser and would ultimately reduce a client’s potential return on investment. No advice may be rendered by Keystone Private Wealth unless a client service agreement is in place.