Legal Tips – Investing Reserve Funds: How Much Risk is Appropriate?

We are all generally aware of the requirements for associations in Illinois to maintain a reserve account (reminder – if it’s a condominium association, the requirement is set by law, but for homeowners’ associations, it may be required by the governing documents). The more advanced question with regard to reserve requirements is how aggressively can the board invest the money? Some associations that have a lot of cash in the bank may want to get more aggressive with their reserve funds (beyond letting it sit in a savings account with a low interest rate or a CD earning not much more). However, before you take any reserve funds and invest it on a hot stock tip, we need to be clear on a few issues.

First, if your association is a condominium, the board has a fiduciary duty to unit owners under Section 18.4 of the Illinois Condo Act, which requires the board to exercise prudent business judgment. As fiduciaries, the board is also bound by the Illinois Trust and Trustees Act, which states that a trustee must be extremely careful with the money it is entrusted to manage (association funds, in this case). All these facts notwithstanding, the fact is, there is no legal prohibition on board members placing investments into non-FDIC insured funds or stocks.

So what’s the answer? Can the board put the money into a stock market or a mutual fund or does it have to effectively “park it under a mattress”? Ultimately, it’s a board decision, but the board must remember that the primary requirement of managing a reserve fund is that the funds are invested in a manner that avoids undue risk and provides ready access to the funds as necessary. In short, the whole point of a reserve fund is to keep the money readily available for emergencies (within reason). Certain investment vehicles can limit a board’s ability to quickly access those funds, making it tough money when the association needs cash for emergency repairs or projects. If the board can locate some very considered, yet possibly uninsured investments (i.e., putting the cash somewhere where the FDIC is not insuring the deposit), there’s no legal restriction preventing the board from making such investments.That said, if the money is tied up in an investment that is not only uninsured, but also illiquid, it is more difficult to access in case of an emergency.

As an example, consider the consequences of having the reserves in the stock market.If an association invests the reserves in the stock market, with an average 10-year return of roughly 10%, remember that is an average return only. If the association takes a big loss on its money during a particular year when it may need to draw on the money, certain association members whose risk tolerance is far lower than the board’s may sue the board based on a breach of fiduciary duty for not keeping the money in an FDIC insured fund. Accordingly, the board must bear in mind its own appetite for the risk, along with its fiduciary duty, as well as the risk-tolerance of other association members.