First published in The Australian, July 2018.
If you have made the decision to set up a self-managed superannuation fund (SMSF), which means taking on the responsibility and control of managing you own super and retirement planning, then no doubt you understand the importance of having the right investment strategy and approach in place.
While these priorities should not be confined only to those with an SMSF, the added responsibilities and obligations for trustees of an SMSF, brings it front of mind.
So, how do you get it right? The best place to start is with the basics.
Having a sound investment strategy is not only a sensible thing to do, it is a legal obligation of SMSF trustees. The law doesn’t set out exactly what the investment strategy needs to look like, or what it must contain, however it does provide some guidance to the effect that the investment strategy for the SMSF needs to consider diversification, which means investing in a range of assets and asset classes, among other requirements. This means SMSF trustees should regard the risk versus the return profile of different assets, and the needs and circumstances of the members of the SMSF.
It is also important to consider the liquidity of the SMSF assets (which means how easily they can be converted to cash) and the SMSF’s ability to pay benefits, for example when members retire and other expenses that may arise. As part of the formulation and regular review of an investment strategy, SMSF trustees also need to consider whether it is appropriate for insurance, such as life insurance, to be held within the SMSF for each of the members.
With no prescriptive formula, there are many different approaches to the investment strategy trustees could take. It’s important to think about a target that you are trying to achieve with the SMSF’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 risk tolerances. As an example, a target of 40% invested in Australian shares, and a tolerance of +/- 20% performance. This enables the trustee to set a target range for what they would like to achieve in terms of performance, without adjusting the investments unless it falls outside of this range. In this example, if the value of Australian shares across the SMSF’s portfolio stayed within 20% - 60% there would be no change required unless the trustee wanted to.
Where some SMSFs get it wrong is to set a target, but allow the tolerance to be too broad (between 0% and 100%). This usually isn’t a sound investment strategy as there is no real goal that the investment strategy can be measured against.
A sound investment strategy is not usually a set and forget approach – it should be reviewed regularly. As a trustee, you can choose to leave the strategy unchanged, or change from one year to the next as required. The big question then is how often should a fund’s investment strategy change?
Provided your investment strategy is in line with the legal requirements such as diversification and liquidity, then your documented strategy doesn’t have to change very often. 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 (e.g. Australian shares), there is plenty of opportunity to make changes within that asset class itself. But remember that there are a number of considerations to take into account when making these changes.
It’s always great to know that you can exit at the peak of a cycle and realise the gains from an investment. However often it’s difficult to know when that peak has come. If an asset has performed really well, it doesn’t necessarily mean it’s time to sell it – although that’s always an option to consider. Remember that selling an asset at what you believe is its peak will mean you have to consider not only the usual transaction costs of changing investments, but also you are realising a potential capital gains tax. Don’t think of capital gains as being an issue, as it means you have made money on the investment, but after allowing for the tax means you will have less value to hold or reinvest.
Another item often overlooked is when trustees choose to purchase property through an SMSF. Due to the level of investment required, this will often be a large percentage of the fund’s value, so can impact an existing strategy with a low allocation to property. Now, remember that you can change the investment strategy at any time, to account for a change in allocation however it’s important to ensure that you have considered and documented why this remains appropriate for the fund and its members taking into account the reduced diversification and liquidity impacts on the portfolio.
While having a carefully considered and documented investment strategy is vital for any SMSF, it’s important to remember that as a trustee, you don’t have to do it all yourself. There are professional advisers that specialise in SMSFs that can help develop an appropriate strategy for the fund and its members, and ensure the fund is meeting its obligations.
Bryan Ashenden is Head of Financial Literacy at BT Financial Group.
This has been prepared by Bryan Ashenden, Head of Financial Literacy at BT Financial Group, a division of Westpac Banking Corporation ABN 33 007 457 14, and is current as at July 2018.
This information 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 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 tax considerations outlined in this article are general statements, based on an interpretation of the current tax law, and do not constitute tax advice. Superannuation is a means of saving for retirement, which is, in part, compulsory. The government has placed restrictions on when you can access your investment held in superannuation. The Government has set caps on the amount of money that you can add to superannuation each year on both a concessional and non-concessional tax basis. There will be tax consequences if you breach these caps. For more detail, speak with a financial adviser or visit the ATO website.