Reserve-ation Please! How to Sensibly Save and Spend Your Backup Funds

How big is your reserve account? That’s a question you probably felt more comfortable answering before 2008, when membership took a dive, dragging revenue down with it. Now that we are all comfortable with the “new normal” of scarcity, what should a reserve profile look like?

“The essentials remain the same for maintaining a solid financial base for an association,” explains Jeffrey Wilcox, president and CEO of nonprofit consulting firm The Third Sector Co. “There is still a need for reserves, an accompanying policy that includes prudent investment guidelines, and revisiting written policies annually to maintain relevance.”

How Much in Reserves Is Enough?

Although the answer will be different for every association, Wilcox is a big advocate of the Seven Measurements from the American Society of Association Executives, which has become the benchmark for a large portion of the association world. According to the Seven Measurements, the formula—or minimum goal—recommended for associations is 50 percent of annual operating expenses. For example, an association with $100,000 in annual operating expenses would strive to maintain at least $50,000 in operating reserves.

Yet, REALTOR® associations often strive for more than the minimum. Kelly Burge, executive officer of the Greater Sioux City Board of REALTORS®, says maintaining operating reserves equivalent to one year of expenses, in addition to $100,000 allocated to legal defense, is comfortable for her association.

Comfort zones and economic hardships don’t always match up, though. For instance, the Quad City Area REALTOR® Association’s reserves dropped to $175,000 in the fall of 2010, an approximate two-month reserve equivalent. By January 2012, however, the organization had begun to replenish reserves by reining in expenses and eking out a small profit on every event, class and transaction.

Over at the Wilmington Regional Association of REALTORS®, N.C., CEO Jerry Panz, RCE, CAE, explains, “Our policy requires we maintain five months of operating reserve for each of our corporations.”

Ultimately, what your association should carry in reserves depends on economic realities, practicality, and comfort. Some AEs are working hard to rebuild previously depleted reserves to ensure the solvency of their organization, while other AEs say having too much of the “members’ money” in the bank right now isn’t responsible.

Consider what other associations do, consult financial experts, and then have an in-depth dialogue with leadership to determine how much is needed to reach that collective level of comfort.

What to Spend Reserves On?

Members have different opinions on a host of things, and the issue of how to spend reserves is no exception. Some AEs say their members want reserves used for lowering their dues, other AEs say their members would rather see deeper cuts in programs, services, and operating expenses before resorting to tapping into reserves.

Your reserve policy should be your best guide. “A good reserve policy addresses investment practices and guidelines for use of principal and yields once the benchmark amount has been reached and maintained,” says Wilcox. For example, after your minimum balance is achieved, will the yields be used for capital improvements, used as working capital for new program development, saved for one-time unexpected expenditures, or used for something else?

Resolve and Revisit

Whatever your association decides, make sure to put it in writing, although this does not—by any means—set it in stone. In fact, your reserve policy and reserve levels should be reviewed annually by the finance committee, which can make recommendations to the board of directors, as necessary.

Wilcox has a word of caution for associations with regard to oversight. “Most associations will create a separate investments committee as a subcommittee of the finance committee. Avoid having the finance committee function as the investments committee, because then you’ve lost your checks and balances system in safeguarding the organization.”

In the end, Wilcox says the ideal situation “is having funds available to do something substantial, unexpected, and extremely meaningful for members. In other words, having the resources to create extra bang for the membership buck.”

Reserve advice from NAR’s Association Investment Program (AIP) managers Morgan Stanley Global Wealth Management

Q. Do you agree that the minimum goal recommended for association reserve funds is 50% of annual operating expenses?

The ASAE Operating Ratio Report is a good source of financial statistics for nonprofit organizations. Our experience with NAR member organizations is they have greater percentages of reserve funds to operating expenses, and therefore they have reached out to learn more about the NAR Association Investment Program (AIP). We provide assistance in developing a cash-flow analysis that tailors the level of reserves to each association. Generally speaking, setting a particular percentage in relation to operating expenses depends on the type of organization (trade association, charitable organization, etc.). A thorough review of an association’s cash flow over a five-year period would help set the level of reserve funds to operating expenses.

Q. Are associations reentering a reserve “build-up” phase, or is it still common to dip into reserves throughout the year?

The Association Investment Program was seeded by NAR in October 2007 and since then the capital markets have been very volatile. Many associations have weathered the storm with minimal financial difficulties, others have taken advantage of the volatility and invested, and others have had a difficult time or have been risk averse. The answer is; it depends on the organization and the current AE or board of directors as to how much risk an association will assume over the short- and long-term time horizon. The AIP has been successful with associations that want to provide for their long-term financial stability by establishing a long-term investment strategy. This strategy is documented in an investment policy that we help create through our investment management services. This policy establishes a spending rate if the association relies on the income from the investment portfolio to support the administration of the association. Some associations simply reinvest to grow the portfolio for the long-term benefit of the association members.

Q. How many REALTOR® associations are now in the AIP?

Currently we are working with 18 associations, with multiple presentations in the pipeline. Associations’ portfolios range from $50,000 to multimillion-dollar portfolios totaling over
$30 million in the program as of Dec. 31, 2012.

Q. How are associations investing today: long-term investments, short-term investments, or moving funds to higher return/higher risk investments?

The desire to build long-term portfolios for the financial stability of associations has outweighed the fear of volatility, especially with short-term interest rates being so low. We have been assisting associations in determining the optimal target for the short-term operating funds and the long-term reserve funds. This is the first tool to control risk of the balance sheet. The second tool is to decide the proper asset allocation for a long-term portfolio. We suggest a “crawl, before you walk, before you run” approach to asset allocation. An association can always increase the risk of the portfolio with the expectation of higher returns. We have also recommended dollar cost averaging into a portfolio over the course of 6 to 12 months to take advantage of a volatile market. These two recommendations have helped boards of directors and finance committees feel comfortable with taking on more risk than short-term money market funds and certificates of deposit.

Q. Do you have any general advice for associations about reserve funds?

In the recent January edition of “On the Markets,” from the Morgan Stanley Smith Barney Global Investment Committee, the accommodative fiscal policy of both the U.S. Federal Reserve and the European Central Bank will bolster financial markets and support weak and slow-growing economies in Europe and the United States. With the major central banks helping to keep interest rates low to support the growth of the economy and financial markets, the Global Investment Committee has cautiously overweighted risk assets but “has stopped well short of a maximum overweight position because the environment remains challenging.” This means GIC recommends taking some risk if an investor or association has the financial capability of assuming more risk than short-term investments. l

Disclaimer: Michael L. Engel, CFA, CIMA, and James Phillips are financial advisors with Morgan Stanley Global Wealth Management in Salt Lake City, Utah. The information contained in this article is not a solicitation to purchase or sell investments. Any information presented is general in nature and not intended to provide individually tailored investment advice. The strategies and/or investments referenced may not be suitable for all investors as the appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives. Investing involves risks and there is always the potential of losing money when you invest. The views expressed herein are those of the author and may not necessarily reflect the views of Morgan Stanley Smith Barney LLC, Member SIPC, or its affiliates.