The Legacy Method can look reasonable at first glance. It produces a neat schedule, a level annual contribution, and a target number for each year.
But even a very simple example raises some basic questions. Let's isolate one component and see what the formulas are doing.
A simple Legacy Method schedule
Here is the same fitness equipment example used elsewhere in these pages, with a Future Replacement Cost of $10,000, an effective age of 2 years, and a lifespan of 10 years.
In this example, the Legacy Method maps out a cash flow like this:
| Year 2 | |
|---|---|
Opening Balance | $589 |
Interest | $17 |
ARFA | $913 |
Expenditure | $0 |
Closing Balance | $1,519 |
CRFR | $1,519 |
Values in the tables are rounded to the nearest dollar.
At first glance, this looks tidy. The fund grows, the closing balance matches ARFA, the schedule points toward $10,000 by Year 10, and the method appears to work.
But what happened in Year 1?
The schedule starts Year 2 with $589 in the fund. If ARFA is supposed to be the level annual contribution, why does the model appear to begin with less than $913? Did the schedule start by under-contributing in Year 1? If not, what exactly is this balance supposed to represent?
A longer timeframe
To explore that, let's expand our timeframe. How does this funding play out over the course of the component's lifespan? ARFA is set at $913 for each year, so we run that cash flow forward as follows:
| Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Year 6 | Year 7 | Year 8 | Year 9 | Year 10 | |
|---|---|---|---|---|---|---|---|---|---|---|
Opening Balance | $0 | $589 | $1,519 | $2,476 | $3,461 | $4,474 | $5,517 | $6,590 | $7,695 | $8,831 |
Interest | $0 | $17 | $44 | $72 | $100 | $130 | $160 | $191 | $223 | $256 |
ARFA | ? | $913 | $913 | $913 | $913 | $913 | $913 | $913 | $913 | $913 |
Expenditure | $0 | $0 | $0 | $0 | $0 | $0 | $0 | $0 | $0 | ($10,000) |
Closing Balance | $589 | $1,519 | $2,476 | $3,461 | $4,474 | $5,517 | $6,590 | $7,695 | $8,831 | $0 |
CRFR | $734 | $1,519 | $2,358 | $3,254 | $4,210 | $5,229 | $6,314 | $7,468 | $8,696 | $10,000 |
Now we have even more questions.
What is CRFR supposed to mean?
Why does CRFR only match the closing balance in Year 2?
Also, in Year 10, the Closing Balance is $0 while CRFR is $10,000. Does that mean the replacement year target is shown as $10,000 even though the reserve fund is expected to end the year at $0 after the expenditure?
Why doesn't ARFA increase over time?
The schedule uses interest and inflated future costs, but the recommended ARFA stays level in nominal dollars: $913 per year, every year.
If time value of money matters, why does the contribution not increase over time?
When do funds become available?
At the start of Year 10, the fund opens with only $8,831. Does this assume the funds only become available at the very end of the fiscal year?
An updated study
Now suppose three years pass and we update the study in Year 5.
Nothing fundamental has changed in the example. It is the same component with the same rates and the same replacement year. The only change is that the Effective Age has moved from 2 to 5.
When the Legacy Method is rerun at Effective Age 5, it gives this:
| Year 5 | Year 6 | Year 7 | Year 8 | Year 9 | Year 10 | |
|---|---|---|---|---|---|---|
Opening Balance | $3,148 | $4,210 | $5,303 | $6,427 | $7,584 | $8,775 |
Interest | $91 | $122 | $154 | $186 | $220 | $254 |
ARFA | $971 | $971 | $971 | $971 | $971 | $971 |
Expenditure | $0 | $0 | $0 | $0 | $0 | ($10,000) |
Closing Balance | $4,210 | $5,303 | $6,427 | $7,584 | $8,775 | $0 |
CRFR | $4,210 | $5,229 | $6,314 | $7,468 | $8,696 | $10,000 |
The CRFR didn't change, but everything else did.
Why did the funding path change?
Back in the original schedule, Year 5 looked different:
| Original schedule | Updated in Year 5 | |
|---|---|---|
Year 5 CRFR | $4,210 | $4,210 |
Year 5 Closing Balance | $4,474 | $4,210 |
ARFA going forward | $913 | $971 |
The target stayed the same, but the path to get there changed.
If $913 was the right annual contribution when the study began, why does it become $971 when we simply move forward to Year 5?
If the original schedule was reliable, why does following it leave the fund above the Year 5 CRFR target, while the updated study calls for an even higher ARFA going forward?
If the fund was on track before, what changed besides time passing?
What this example shows
This example is not a full proof, but it shows why the Legacy Method deserves closer review.
A reserve funding method should behave like one coherent year-by-year model. If we follow its recommendation and later update the study, the method should still make sense on its own terms.
- For the full explanation of how the Legacy Method falls short, see Legacy Method: Technical Review.
- To see the Reserve Sense Benchmark Method step by step, go to Walkthrough.
- For the exact formulas and variables that Reserve Sense uses in its models and software, see Formula Reference.