The mix of investments that is right for an SMSF will depend on very personal factors, including SMSF members’ age, lifestyle, attitude to risk and personal goals.
And it’s not a case of set and forget – SMSF trustees’ approach to SMSF investing may need to change over time as retirement approaches and priorities change.
Why is diversification so important to SMSF investing?
Diversifying an SMSF investment portfolio means having money invested across a range of different investments so that the SMSF is not over-exposed if particular areas of the market fall in value. That might mean spreading money across different asset classes, regions, industries, and investment managers.
Asset classes behave differently at different times – some asset classes will rise in value while others fall. Diversifying across different asset classes helps an SMSF to smooth out overall returns. On the one hand, this could mean missing out on some ‘upside’ if the SMSF is not fully invested in the best performing asset class. On the other hand, this could mean avoiding the potential impact of having all the SMSF’s money invested in an asset experiencing a significant downturn.
Asset classes that can be used to diversify an SMSF portfolio
Diversification can be achieved through “asset allocation” - the way money is spread across different types of investments. It involves identifying the investments that match SMSF members’ goals and risk tolerance, then allocating a certain percentage of the SMSF portfolio to each asset class. It’s important to understand the benefits and risks of different types of investments.
Cash generally refers to investments in the short-term money market including short-term bonds issued by high quality companies or governments. ‘Short-term’ typically refers to investments that mature in less than 12 months.
Cash has historically generated the lowest returns of the four major asset classes over the longer term and values may be eroded by inflation.
Fixed interest assets (also called “fixed income”) include corporate and government bonds. They work like a loan from the investor to the bond issuer, and offer benefits such as regular income returns at a set interest rate, over a fixed term.
Fixed interest investments generally involve lower risk than shares and property, but sit higher on the risk spectrum than cash. Corporate bond investors risk losing all or part of their initial investment if the company issuing the security fails.
Listed property trusts provide a simple way to invest in residential and commercial property without tying up a large proportion of money directly in real estate. Because investment is through the sharemarket, investors can sell securities relatively easily if necessary (unlike direct property investments).
Like shares, units in listed property trusts can rise and fall in value. Returns are affected by fluctuations in the supply and demand for properties and consequential changes in rental levels, as well as by interest rates. Global property securities can also be affected by social, economic or political factors, differing tax structures in foreign tax jurisdictions, and foreign regulatory requirements.
Shares, also called stocks or equities, enable investors to buy a slice of a public company. As part-owners, investors may be entitled to a stake in the company’s profits in the form of dividends. As the company’s business grows over time, the value of the shares may grow, and this can provide capital growth for shareholders.
Share prices can rise and fall and the payment of dividends and the return of capital are not guaranteed. Investors face the risk that a company, or the industry in which it operates, may not perform as well as expected or that there may be adverse changes in a company’s financial position.
How else can an SMSF portfolio be diversified?
Managed investments can be a solution for investors seeking professional expertise and a strong level of diversification. Managed investments take the hard work out of selecting which assets to buy and sell, and when to do it – instead a professional investment manager does this.
Managed investments can invest across the full spectrum of asset classes, including cash, fixed income, property and shares. They can focus on a specific asset class such as shares, a particular industry, or even a specific country.
Managed investments can provide a level of diversification well beyond the reach of most direct investors. An Australian share fund, for example, could hold shares in dozens of Australian companies; a property fund can hold major assets like a commercial office block.
Two types of managed investments SMSF trustees may want to consider are:
- Managed funds – investment vehicles where the money contributed by a large number of investors is pooled and managed as one overall portfolio by a professional investment manager. Investors purchase units in the fund which entitles them to an interest in a pool of assets with the other unit holders.
- Managed portfolio – similar to managed funds except that instead of owning an interest in a pool of assets, a portfolio of assets is bought specifically by the SMSF trustee on behalf of the SMSF’s members and the SMSF is the beneficial owner of all the assets in the portfolio. This means the SMSF receives the potential benefits of income, dividends, franking credits and potential capital growth, as well as some tax benefits.
However, along with risks outlined above for individual asset classes, managed investments carry the additional risk that the investment manager(s) chosen may not perform as expected.
This information is general in nature and does not take into account your personal needs, objectives or circumstances and therefore, before acting on it, you should consider whether it is appropriate for you.
BT Portfolio Services Ltd ABN 73 095 055 208 AFSL 233715 (BTPS) is the operator of BT Panorama (the investor directed portfolio service). BT Funds Management Limited ABN 63 002 916 458 AFSL 233724 (BTFM) is the issuer of BT Cash. Westpac Financial Services Ltd ABN 20 000 241 127 AFSL 233716 (WFSL) is the issuer of BT Managed Portfolios (together, the Panorama Products). An Investor Guide is available for BT Panorama and a PDS is available for BT Cash and BT Managed Portfolios and can be obtained by calling 1300 554 267, or visiting BT SMSF. You should obtain and consider the relevant disclosure documents before deciding whether to acquire, continue to hold or dispose of interests in the Panorama Products. In addition, BTPS is also the provider of the SMSF Establishment Service and the SMSF Administration Service. The Guide and Terms and Conditions for each of these services are available by contacting BTPS.
BT Portfolio Services cannot give tax advice. Any tax considerations outlined in this article are general statements, based on an interpretation of the current tax law, and do not constitute tax advice. The tax implications of BT SMSF can impact individual situations differently and you should seek specific tax advice from a registered tax agent or registered tax (financial) adviser. Information current as at 8 February 2017.