Gyroscopic Investing

I am on the board of my HOA and I recently got the bright idea of bringing up the topic of tweaking the HOA's investment policies to better match the HOA's reserves currently held for future capital improvements and repairs against the approximate time those liabilities will need to be addressed (typically 5-20 years in the future).

The HOA currently holds all of these reserves in 12 month CDs, which means the HOA is losing about 3% or so a year in purchasing power.

To put it mildly, my suggestion of a bit more prudent risk in our approach to asset management was not met with enthusiasm.  The sense seemed to be that no risk of any kind with these assets is acceptable, but when I pointed out what they are currently doing is actually quite risky from the perspective of actually being able to maintain purchasing power leading up to the future capital improvements, this concept just didn't seem to fully register with some members of the board.  No matter how many ways I tried to describe the inflation risk in the current approach and the serious need to match the current assets with the future liabilities they were intended to fund, some members just didn't seem to have a clue what I was talking about.

It's probably a waste of time to try to make people see things they don't want to see, but it was a pretty bizarre feeling to be viewed as the guy who wants to adopt a risky approach to investing when I am usually the most conservative guy in the room (and I think that I was actually one of the most conservative guys in the room tonight, but for whatever reason some people didn't seem ready to see that).

One member was so mad by the end of the meeting her face turned red and she wouldn't even look at me.  She was convinced that I was trying to ruin the HOA's finances by losing all of its money in the markets.

Very odd experience.

You should have given them a copy of your book.  That would have made you an expert worthy of being listen to and taken seriously.

I bumped into the same inability to understand inflation risk while speaking to my parents one time. They just couldn't contain their excitement while talking about their savings accounts earning 11% in the 70s. Try as I might, I just could not get them to understand that inflation was actually killing their purchasing power anyway despite the high nominal returns. Every time I thought I'd gotten through, a few minutes later one of them would say something like "the money we put in CDs doubled over the course of a few years!" Yes, but those dollars' purchasing power was halved! I just couldn't make it stick.

smurff wrote: You should have given them a copy of your book.  That would have made you an expert worthy of being listen to and taken seriously.

I actually brought a copy of the book with me to share with them. 

As the discussion progressed, though, the book just seemed to puzzle them. 

You know how it is when you're dealing with people in your daily life--often getting respect from them is WAY harder than it is to get respect from people at a greater distance.

You brought the book to the meeting?  Then what's wrong with those people???!!!!!

I suppose the problem is that everyone on the HOA management knows that it is not really their money that they are taking care of but rather that of all of the residents. They probably don't consider that they are qualified to invest other people's money. Holding cash is probably seen as being  the "do no harm" option.

MediumTex wrote: Very odd experience.

Time to sue them for breach of fiduciary duty.  Take no prisoners!!!

I had exactly the same thought for my coop's long range savings.  It's even worse for us:  the board did what I considered to be a disastrous refinance of the underlying mortgage, paying $1.7M in penalties on a balance of around $5.5M, then borrowing another $2.5M for the reserve fund.  So we're effectively paying 4.8% interest on that reserve (plus the penalties), while holding it in CDs.  The board of course trumpeted this as saving money, since the original mortgage was 8% and monthly payments did go down about 15%.

If your HOA is anything like this board, I'm afraid you won't make much headway.  One possibility is to try to get them interested in a fund that invests in the same asset classes as the PP, but has the goal of remaining very stable while preserving real purchasing power.  There was one mentioned somewhere on this board.  If you keep harping on the long term effects of inflation, either the message will sink in or they'll cave in just to get you to shut up :-).

The book is great, but I think that in most situations like this people require something that fits on a postcard.  Maybe half of a postcard.  It might have been easier to just suggest taking a percentage of the reserves and heading to Vegas.

flyingpylon wrote: The book is great, but I think that in most situations like this people require something that fits on a postcard.  Maybe half of a postcard.  It might have been easier to just suggest taking a percentage of the reserves and heading to Vegas.

What I actually had in mind was something far easier to explain: I was going to suggest taking what is currently 100% invested in bank CDs and suggest that we invest 25% of that in a one-stop fund like Vanguard Wellesley, and then "rebalance" annually between the bank CDs and Wellesley shares to restore the 75% CDs/25% Wellesley split.

I went with a Wellesley-like approach to the risk portion of the portfolio precisely because I assumed others would be familiar with this approach and it wouldn't be necessary to do the difficult work of explaining the PP to a group of people (or neighborhood full of people).

However, we never got past the idea of even reviewing the current 100% CD approach.  Some of the members apparently felt insulted that anyone would question the wisdom of a 100% bank CD strategy used to fund multi-decade liabilities.

You may have lost them with that rebalance strategy.  How about proposing to put just the long term (>5 years) savings into a fund like Wellesley, and keeping the short term savings in CDs?

Also, do you happen to know if your HOA's reserve fund is entirely FDIC insured?  That question came up for us.  If you have two $250,000 CDs with the same bank, are those considered two accounts for FDIC purposes?

But I thought all market participants were rational...

Training your mind to think in real terms rather than nominal terms is a huge boost to ones financial IQ.

This reminded me of a paper by Robert Shiller about the public's perception of real and nominal interest rates:

[quote=Robert Shiller, page 15]The Real Interest Rate in the Public Mind

The theory presumes that real interest rates are natural concepts to use to describe
public decisions. However, in fact, the real interest rate is not even a concept that many
people use to frame their decision-making when they think about asset prices.
The concept of the real interest rate dates back to 1895 with Columbia University
economics professor John Bates Clark whose name is memorialized in a prestigious
economics medal that the American Economic Association awards today. In describing
the concept, he seemed to be presenting it as a strikingly original new idea that he needed
to explain at some length. He wrote about a widespread confusion, that he discerned in
the then-current debate about bimetallism, about the interpretation of interest rates.
Discussing the example of a debtor in an environment with one percent deflation, he
noted that “If he pays a nominal rate of five percent in interest, he may pay a real rate of
six.”? 15

  In the following year, 1896, Yale University’s Irving Fisher wrote about the same
popular confusion, but did not use the term “real rate”? but instead “virtual interest in
commodities.”?  He also noted the lack of public understanding of the basic concept: “It is
an astonishing fact that the connection between the rate of interest and appreciation has
been almost completely overlooked, both in economic theory and in its bearing upon the
bimetallic controversy.”? 16

  He was right to be astonished, for indeed the significance of
any interest rate depends critically on the inflation rate, and referring to nominal interest
rates alone may be regarded as almost meaningless. 17

Clark’s long discourse on the elementary concept of real interest rates and
Fisher’s astonishment at the lack of public understanding reflect their recognition of the
importance of what today are classified as behavioral biases in popular economic
thinking, notably a bias called “money illusion,”? a term coined by Fisher in 1928. But,
failure to think in terms of real interest rates rather than nominal rates, while it may be
described as an “illusion,”? is perhaps better described as just an abject failure to
understand the concept. The concept of real interest rate remains totally absent from the
popular model of the economy. 
[/quote]

http://cowles.econ.yale.edu/P/cd/d16a/d1632.pdf

This reminds me of that story of the guy who ventures into a strange land where people are afraid of the melons growing in a field, as if they're monsters. The stranger pulls out a machete and slices one of the melons in half, and the locals promptly turn on him in their fear. One day, a new stranger arrives, hears the same warning, and agrees that yes, we need to be careful about these creatures. He speaks softly, and little by little, teaches the melon-fearers about the world.

Anyway, I can see where the book might be too much to swallow in a short time, even if it does give you credibility. What you need is to show them that another HOA is investing successfully and leaving their HOA (your HOA) in the dust, and that other HOAs would consider it a crime to let inflation eat up their savings. Even though you're right, they won't listen to you because you're on the inside and they're afraid of change. (I'm sorry to admit this, but I love the image of the woman with the red face).

Alternatively, you could try to convince just one other person on the HOA, the most conservative fuddy duddy in the group, outside of the regular meetings. A cocktail is recommended. But, this is at least as difficult as persuading the entire group in the first place.

Can anyone tell me what the appeal of HOAs and co-ops is? From my perspective, it sort of seems like you're paying people to oppress you. Is the supposed preservation of property values and community areas worth the monthly payments and dealing with the frightened rabbits who control the whole collectivist enterprise?

WiseOne wrote: You may have lost them with that rebalance strategy.  How about proposing to put just the long term (>5 years) savings into a fund like Wellesley, and keeping the short term savings in CDs?

I wanted to start off more conservative than that.  I need to be able to show that there is virtually no risk to the "principal."

Also, do you happen to know if your HOA's reserve fund is entirely FDIC insured?  That question came up for us.  If you have two $250,000 CDs with the same bank, are those considered two accounts for FDIC purposes?

Oh yes, the funds are in multiple banks and they are all below the FDIC limit, and that was a point of great pride.  One woman kept asking me if my recommendations would include a "guarantee".  I told her that the only guarantee I could provide is that any recommendation I would make would NOT consistently lose out to inflation every single year, which is what is happening every single year under the current investment "strategy."

MT,

I have been thinking about bringing the same topic up in our HOA meetings. We are on a similar 12 month CD plan. What about an approach that uses TIPS, I-Bonds, EE-Bonds combined with a 25% total market index...rebalanced annually?

Can a condo association even purchase TIPS, I-bonds, or EE-bonds?

doodle wrote: MT,

I have been thinking about bringing the same topic up in our HOA meetings. We are on a similar 12 month CD plan. What about an approach that uses TIPS, I-Bonds, EE-Bonds combined with a 25% total market index...rebalanced annually?

Can a condo association even purchase TIPS, I-bonds, or EE-bonds?

I would just say good luck.  Cutting through sloppy and/or misguided thinking can be a LOT harder than it looks.

What I find ironic is that my objective was simply to help.  I have no financial interest in the HOA making good decisions, other than my desire not to pay higher dues.  It wasn't like I was selling something that would benefit me personally and they were just resisting my pitch. 

I've been whittling away on the board on a number of other issues over the last few months and seem to be making headway. I have found that it is best to take a very light handed approach and come with some very simple numbers or diagrams on a piece of paper. If you see that someone is in a bad mood or is going to put up a fuss, then let the issue go and start gently working the back channels....emails and quiet hallway conversations.

I guess you could say its a lot of effort for little reward, but I kind of look at it like a big game. Its fun building alliances and trying to out maneuver the resistance. :-) Its kind of like a real world version of the board game "Diplomacy" or if you're more into TV shows...like Condo Survivor.

doodle wrote: I've been whittling away on the board on a number of other issues over the last few months and seem to be making headway. I have found that it is best to take a very light handed approach and come with some very simple numbers or diagrams on a piece of paper. If you see that someone is in a bad mood or is going to put up a fuss, then let the issue go and start gently working the back channels....emails and quiet hallway conversations.

I guess you could say its a lot of effort for little reward, but I kind of look at it like a big game. Its fun building alliances and trying to out maneuver the resistance. :-) Its kind of like a real world version of the board game "Diplomacy" or if you're more into TV shows...like Condo Survivor.

Those are all good thoughts and reflect a realism about dealing with other people.

I imagined this situation might move like a turtle, but perhaps I was in too big a hurry.  It may be better to think of it as moving like an oak tree or perhaps a glacier.

doodle wrote: I've been whittling away on the board on a number of other issues over the last few months and seem to be making headway. I have found that it is best to take a very light handed approach and come with some very simple numbers or diagrams on a piece of paper. If you see that someone is in a bad mood or is going to put up a fuss, then let the issue go and start gently working the back channels....emails and quiet hallway conversations.

I guess you could say its a lot of effort for little reward, but I kind of look at it like a big game. Its fun building alliances and trying to out maneuver the resistance. :-) Its kind of like a real world version of the board game "Diplomacy" or if you're more into TV shows...like Condo Survivor.

diplomacy was a great game, when all the other nerds were into playing D+D we were playing diplomacy..

HOA and other groups always bring me to think of Sayre's Law:

http://en.wikipedia.org/wiki/Sayre's_law

Sayre's law states, in a formulation quoted by Charles Philip Issawi: "In any dispute the intensity of feeling is inversely proportional to the value of the issues at stake." By way of corollary, it adds: "That is why academic politics are so bitter." Sayre's law is named after Wallace Stanley Sayre (1905-1972), U.S. political scientist and professor at Columbia University.

Yep, "glacial" would be a good descriptive word. We had past president that got things done with a strong handed approach but he paid for it dearly and had to endure a lot of personal attacks. Working out a consensus takes longer and is a delicate process, but at the same time a great learning experience that gives one an up close an personal view of some of the challenges that politicians in washington face HOA politics is little leagues compared to what goes on in the nations capital though. While a lot of those guys are weasels, i realize now how important level heads and compromise are to solving this nations problems.

So back to issue... What woud be the ideal way to invest HOA reserves, protect against inflation, and ensure liquidity? Is this not a good situation for TIPS mixed with stocks? Can association possibly purchase i or ee bonds or are these limited to individuals?

MediumTex wrote: However, we never got past the idea of even reviewing the current 100% CD approach.  Some of the members apparently felt insulted that anyone would question the wisdom of a 100% bank CD strategy used to fund multi-decade liabilities.

Instead of suing, you might want to seduce them in baby steps over time.  Why don't you bring up 5-year CD laddering at the next meeting and go from there?

doodle wrote: So back to issue... What woud be the ideal way to invest HOA reserves, protect against inflation, and ensure liquidity? Is this not a good situation for TIPS mixed with stocks? Can association possibly purchase i or ee bonds or are these limited to individuals?

TIPS held to maturity might be a good option, but explaining how bonds work to a novice can be difficult, especially if they are already predisposed not to want to understand what you are telling them.