A new year can be a good time for SMSF trustees to revisit finances with an eye to reviewing their SMSF investment strategy.
By Bryan Ashenden, Head of Financial Literacy and Advocacy at BT
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 SMSF 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 SMSF 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 probably 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 usually important for SMSF trustees to spend some time making an assessment of these important characteristics.
However, it is unlikely that a consideration of risk and return is just limited to the actual investments themselves. Often the best starting place is what the SMSF trustee’s risk and return parameters are. If the market was to fall by 10 per cent, how long would they be willing to stay invested in the same asset to recover the capital? This can help determine how much risk the SMSF trustee is willing to take on. And this consideration may not be about a particular investment, but rather the composition of all the assets in the SMSF. How much to allocate to growth assets (which usually have higher risk) compared to how much to invest in more stable investments (which are generally subject to less volatility).
Risk may only be 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.
Another requirement may be 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 SMSF, 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 arguably more 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 SMSF.
SMSF 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.
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 SMSF investment strategy? It's likely one that aligns to the future goals of the members (the trust deed should cover this) and what they are trying to achieve, and ensures this is done with appropriate consideration of the risks in achieving these goals. It should also comply with super legislation and the sole purpose test.
Finally, while the start of a new 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.
This was prepared by Bryan Ashenden, Head of Financial Literacy and Advocacy, BT, a part of Westpac Banking Corporation ABN 33 007 457 141 AFSL & Australian credit licence 233714. Information current as at update November 2019. 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.