Interest assumptions
The rate a reserve study assumes your reserve fund will earn, and why it matters less than you'd think.
A reserve study's interest assumption is the rate of return the preparer assumes the reserve fund will earn on money already saved. It applies only to existing reserve dollars, not future contributions, and it matters far less than the inflation assumption, which raises the projected cost of every component the association will eventually replace.
What the interest assumption covers
A reserve study's financial analysis has two parts: where your reserves stand today, and the funding plan going forward. Both are built on stated assumptions, and one of them is an interest rate, the return the preparer expects the reserve account to earn.
That rate applies to dollars that are already sitting in the reserve account, earning a return year after year. It does not apply to next year's assessments or to any contribution the association hasn't collected yet. A board that raises the assumed interest rate on paper hasn't found new money, it has just changed a projection about money that's already there.
Why inflation moves the number more than interest does
Interest and inflation pull the funding plan in opposite directions, but not by the same amount. Interest grows the balance you already have. Inflation raises what every future project will cost to build, and it applies to the full replacement cost of every component in the study, not just the cash on hand.
"Inflation has a much greater impact on the funding plan."
Source: What's Included in a Reserve Study? Key Elements Explained, Reserve Advisors
That's why a small change to the inflation assumption tends to shift a funding plan much more than the same size change to the interest assumption.
What to ask before you accept the plan
A usable reserve study discloses both assumptions and lets the board see how they were chosen. There is no legally required interest rate, so if your study states a number without explaining it, that's a question for the preparer, not something to take on faith.
It also helps to sanity check the rate against how reserves are actually invested. Associations generally hold reserves for safety and liquidity first, often spread across insured bank deposits, which tends to produce modest returns. An assumed interest rate that looks aggressive next to typical insured-deposit yields is worth pushing back on. How conservatively your board is required to invest reserves, and whether your state restricts the options, varies; check your governing documents and your state's statute.
Check yourself
Answer before you read the explanation, recalling it is what makes it stick.
Your reserve study assumes a 2% interest rate. A board member says raising it to 5% would fix the shortfall. What's the flaw?
Two reserve studies for similar associations show very different funding needs. One preparer used a higher inflation assumption. What does that most likely explain?
A reserve study report doesn't state what interest rate it assumed. What should the board do?
Sources
- National Reserve Study Standards (overview), Community Associations Institute
- What's Included in a Reserve Study? Key Elements Explained, Reserve Advisors
- Association Investing and FDIC Limits, CH&P Management
Reserves
Next, see how the inflation assumption drives the same funding plan.
Whether your reserve study discloses its interest rate assumption at all, and how conservatively your board is required to invest reserve funds, varies by preparer and by your association's own investment policy.