Reserve funds are similar to an emergency fund. They comprise money held in a savings account or another type of liquid asset that can be accessed when funds are needed. Typically, reserve funds are made up of cash and allow you to cover unexpected costs or financial obligations. Reserve funds are especially popular with companies, financial institutions, and homeowners associations (HOA).
Keep reading to gain a deeper understanding of how reserve funds work and what they’re typically used for.
Definition and Examples of Reserve Fund
Reserve funds usually exist in the form of a savings account or some other type of liquid holding place for cash that can be accessed if an unexpected (or anticipated) cost arises. Reserve funds are becoming increasingly popular among investors, but they are also used by financial institutions, companies, and HOAs.
For example, a family may use a reserve fund to cover costs like unforeseeable medical care or home repairs. Likewise, an HOA charges its members a monthly fee, part of which goes toward a reserve fund to pay for neighborhood maintenance and improvements.
Reserve funds aren’t just a safe space to store cash funds; this type of fund should also help you increase your money by paying out interest on the savings. This interest can help grow the fund’s value, so the less you end up pulling from it, the more you will earn on your savings.
Real estate investors also use reserve funds to help ensure that if a pricey, unexpected repair comes up, they will be able to weather it. The last thing any real estate investor wants is resorting to expensive financing options, such as credit cards, to cover unplanned costs like replacing a furnace or fixing water damage.
Social Security is yet another example of a reserve fund. Money that is earmarked for Social Security benefits is collected in advance and interest on those savings helps expand the reserve fund.
How Reserve Funds Work
You will likely have experience with reserve funds if you live in a neighborhood with an HOA or a condominium complex. In a condo building or housing subdivision, an HOA or condo association usually governs the housing community. Typically, these associations have officers and leadership who are responsible for maintaining the community by scheduling maintenance and repairs, creating rules for residents to adhere to, hiring service workers, and approving projects that better the community.
This is where a reserve fund comes in. While certain ongoing costs like window cleaning and landscaping will be planned for in advance, a reserve fund can provide money when an emergency occurs or to cover the cost of major scheduled renovations or remodeling. To build out the reserve fund, residents will pay HOA dues monthly.
HOA fees are usually used in two main ways. Some of the money goes toward monthly operating costs; the remainder is deposited into the reserve fund. No one is allowed to use the reserve funds unless the HOA board or owners at the condominium authorize it.
Pros & Cons of Reserve Funds
- Easy access to funds in an emergency
- Helps avoid debt
- Generates income on savings
- Savings growth is limited
- Owners or officers may be reluctant to contribute
- Easy access to funds in an emergency: Reserve funds are liquid, making it easy to access that cash when necessary.
- Helps avoid debt: When you have an emergency fund, you’re less likely to turn to high-interest borrowing options.
- Generates income on savings: Reserve funds generate interest income on the savings in the fund.
- Savings growth is limited: Generally, you’ll earn more by investing money instead of leaving it to earn interest in a savings account.
- Owners or officers may be reluctant to contribute: People called upon to give to a reserve fund may think it’s an unnecessary expense.
- A reserve fund is similar to an emergency fund. It’s a liquid account that is easy to access.
- Generally, reserve funds are made up of cash. They are especially popular savings vehicles for companies, financial institutions, and homeowners associations (HOA).
- Reserve funds earn interest on the cash they contain, so the more money that’s in such a fund, the more interest income the account generates.