So, how do you get it right? The best place to start is with some of the basics.
Having a sound investment strategy is not only a sensible thing to do, it is an obligation of SMSF trustees. An investment strategy for an SMSF should consider diversification (investing in a range of assets and asset classes). This means the trustee should have regard to the risk versus the return of different assets, and have regard to the needs and circumstances of the members of the fund.
It is also important to consider the liquidity of the fund’s assets (or how easily they can be converted to cash) and the fund’s ability to pay benefits (when members retire) and other expenses that arise. As part of the formulation (and regular review) of an investment strategy, trustees also need to consider whether it is appropriate for insurance (such as life insurance) to be held within the fund for each of the members.
There are many different approaches that may be taken to formulating an investment strategy, and unfortunately this is where some trustees could get it wrong. You may wish to think about a target that you are trying to achieve with the fund’s investment – for example, CPI + x% return (you insert the “x”) over a 5 year period. This takes into account the fact that investments (and markets) can and do fluctuate over time. Many investment strategies also nominate a targeted asset allocation by asset class, as well as tolerances. Again, as an example, a target of 40% invested in Australian shares, and a tolerance of +/- 20%. Using this really says that as a trustee you have a target you would like the SMSF to achieve, but the SMSF remains within its strategy if the value of Australian shares across the SMSF’s portfolio stays within 20% - 60%.
Some SMSFs may set a target, but allow the tolerance to be between 0% and 100%. This may be too wide a tolerance for the SMSF and may not be helpful in assisting them meet their target.
What you do need to remember though with an investment strategy is that it is never set and forget – as there is a requirement to review it regularly. You can choose to leave it unchanged, or change from one year to the next as required. The big question then is how often should it change?
Provided you continue to have your investment strategy in line with the legal requirements such as diversification and liquidity, then your documented strategy doesn’t necessarily have to change unless the circumstances of the SMSF or the members have changed. Importantly though, this doesn’t mean that you can’t change the underlying investments more frequently. Considering that an investment strategy is usually set at an asset class level (eg Australian shares), there is plenty of room to make changes within that asset class itself. There are a number of considerations in making these changes.
Trustees may have intentions to exit at the peak of the cycle. The problem is you never know when that peak has come. Just because an asset has performed really well doesn’t necessarily mean it’s time to sell it. Remember that if you are selling an asset at what you believe is its peak, you should also take into consideration other matters such as transaction costs and tax consequences of selling investments. These matters may mean you have less proceeds to reinvest.
One other big item often overlooked is when SMSF trustee’s choose to purchase real property. This will often be a large percentage of the fund’s value so you should ensure that you have considered and documented why this reduced diversification and reduce liquidity remains appropriate for the fund and its members.
Whilst having a carefully considered and documented investment strategy is vital for a SMSF, you also don’t have to make all the decisions yourself. There are professional advisers that specialise in SMSFs that can help you develop an appropriate strategy for the fund and its members, and give you a greater level of comfort that the fund is meeting its obligations. After all, SMSF doesn’t have to mean DIY.
This article was prepared by BT, a part of Westpac Banking Corporation ABN 33 007 457 141, AFSL and Australian Credit Licence 233714. This information is current as at 15 July 2019. This article provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such. It does not take into account your personal objectives, financial situation or needs and so you should consider its appropriateness, having regard to these factors before acting on it. 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.
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