With a new financial year having started and many self-managed superannuation funds (SMSFs) in the process of finalising their accounts for last year, it's an opportune time for trustees to review, and possibly renew, their fund's investment strategy.
The question is: what is a good investment strategy? Unfortunately, there is no simple answer.
Super law does set out some requirements that trustees of regulated super funds need to consider when formulating an investment strategy, including (but not limited to) the composition of investments, risk and return, liquidity, insurance and the ability to pay liabilities (including member benefits) as they become due.
Looking first at the composition of investments, there isn't a requirement that SMSF investments must be diversified, and there are some SMSFs that have large investments in a single asset or asset class. Most commonly this occurs where the fund has a direct property investment, with a comparatively smaller investment in cash in order to make relevant payments as necessary.
Whether or not this approach is right is a question for the trustees of each fund to determine for themselves, but the old saying of "not putting all your eggs in one basket" is worth considering. Using this example, what would happen if the property market was to fall? Do you have enough time to ride out fluctuations and get your money back? This points to the next consideration of risk versus return.
With any investment decision, a consideration of the risk involved in a particular investment balanced against the potential returns or reward should always be undertaken. Of course, these are both forward looking. History may tell us a little about the risks and returns for particular investments over a period of time, but there are no guarantees about what will happen in the future. This is why it's important for trustees to spend some time making an assessment of these important characteristics.
However, don't think that a consideration of risk and return is just limited to the actual investments themselves. The best starting place is to understand what the trustee’s risk and return parameters are. If the market was to fall by 10 per cent, how long would you be willing to stay invested in the same asset to recover your capital? This can help determine how much risk you are willing to take on. And this consideration may not be about a particular investment, but rather the composition of all the assets in the fund. How much to allocate to growth assets which offer a higher risk compared to how much to invest in more capital stable investments which are generally subject to less volatility.
Remember that risk is only one side of the equation - return may be equally as important to consider. In fact, given one of the key objectives of super is to grow wealth towards retirement, generating an appropriate level of return is important, and invariably involves taking on some element of risk.
The third requirement is around consideration of liquidity and the ability to pay liabilities as and when they fall due. There is no doubt that you need to be able to pay for the ongoing running costs of your fund, but consideration of liquidity takes on heightened importance as members approach retirement. With super used to fund members' retirement lifestyles, the need to ensure there is sufficient liquidity is vitally important, and will involve a consideration of how much should be held in cash (or other liquid investments) and how much should stay invested in less liquid investments to provide for future potential growth in the fund.
Trustees are also required to consider the insurance needs of members in formulating the investment strategy. Given that quite often the trustees of an SMSF are also the members of the SMSF, this is about considering whether you have sufficient insurance of your own, and if not, whether you should acquire more cover through your super.
But don't constrain yourself to just considering personal insurance, even though that's all that's technically required. Depending on the type of investments in your SMSF, you should also consider if you need the fund to take out other types of insurance. This could be an important consideration if you hold property.
So what makes a good investment strategy? It's one that aligns to the future goals of the members and what they are trying to achieve, and ensures this is done with appropriate consideration of the risks in achieving these goals.
Finally, while the start of new financial year is an opportune time to review the investment strategy for your SMSF, don't forget that it's a requirement for trustees to do so on a regular basis.
Written by Bryan Ashenden, Head of technical literacy and advocacy at BT Financial Group.
Information current as at August 2017. This information does not take into account your personal objectives, financial situation or needs and so you should consider its appropriateness, having regard to your personal objectives, financial situation and needs having regard to these factors before acting on it. This information provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such. This information may contain material provided by third parties derived from sources believed to be accurate at its issue date. While such material is published with necessary permission, no company in the Westpac Group accepts any responsibility for the accuracy or completeness of, or endorses any such material. Except where contrary to law, we intend by this notice to exclude liability for this material. Any super law considerations or comments outlined above are general statements only, based on an interpretation of the current super laws, and do not constitute legal advice. This publication has been prepared by BT Financial Group, a division of Westpac Banking Corporation ABN 33 007 457 141 AFSL & Australian credit licence 233714.