Knowing exactly what needs to be considered before getting your asset allocation right inside (or outside!) a Self-Managed Super Fund (SMSF) is not just a smart move in terms of obeying strict SMSF regulations. It is also a fantastic exercise in developing a broader investment discipline.
No matter your age, gender, risk profile, objective or income, for every investor there is a single golden rule–diversify. It is a truth universally acknowledged that a diversified investment portfolio is likely a safer one, as it will potentially weather storms in a more balanced fashion than a portfolio that is heavy with one specific asset or asset class.
Members of SMSFs are required by regulation to consider the diversification of their fund’s portfolio. The law insists that SMSF members put in place an investment strategy that considers diversification (among other factors) and review it on a regular basis. Then members must ensure their fund’s asset mix matches their investment strategy document.
But what should this consideration involve before such a document is written? How does an SMSF member, or anybody with an interest in the responsible and reasoned diversification of their portfolio, ensure they are asking the right questions of their own risk appetites and resulting asset class percentages?
Each SMSF member or investor will have different reasons for diversifying. For some it will be for greater chances of balancing risk and return in turbulent markets. For others it will be to take advantage of opportunities in various geographical locations. Some will diversify because of the varying time requirements of particular asset classes, holding some asset classes for longer than others and constantly re-balancing.
How do you figure out your own risk profile? Seek professional advice for an in-depth analysis, but it has a great deal to do with your stage of life, and therefore how much time you can afford to wait out the various ups and downs of the market. It also involves other considerations. How much do you have to invest and how regularly? How do you feel about seeing your portfolio fluctuating in value? What are your individual tax circumstances?
Regulations specific to SMSFs outline the fact that you must show consideration to five essential points before writing your investment strategy. These are:
1 Consider the risk and likely return from the fund’s investments taking into account the member’s needs and circumstances.
2 Consider the solvency of your fund. In other words, can it afford to pay benefits to members when required, and pay its own bills such as auditing, accounting and legal?
3 Analyse the role and level of diversification in your fund. What is its purpose? What are the risks if there is inadequate diversification?
4 Analyse the level of liquidity of the fund’s assets, and the role and purpose of this liquidity.
5 Is there insurance for members within the fund? You must be able to prove that you have at least considered whether the fund should hold insurance for SMSF members.
In the world of Australian SMSFs, cash and shares are the front runners, with both typically making up around 30% each of an average fund’s total assets.1 Property, including commercial and residential, takes third place with an average of less than 20% of each fund’s value.
There are several other asset classes that can be considered for ownership within SMSFs, and it is a good idea to seek professional advice on exactly what is and is not allowed. Listed property trusts, foreign property and managed funds tend to be accepted. Artworks, precious metals and vintage cars etc may also be allowed, but professional advice should be sought before purchase. More complicated financial vehicles such as warrants and derivatives also require special advice.
Interestingly, in certain situations if you currently own your business’s commercial property, then the SMSF can buy the property from you under a Limited Recourse Borrowing Arrangement at market value, then you rent it back from the fund. This may mean lower tax on rental income and eventual capital gains tax on sale, compared with holding the property outside of super.
There are many very specific rules and regulations for assets held within an SMSF. For instance, if an investment benefits you at all now, instead of after retirement, then it is unlikely to be allowed in your SMSF. Please seek professional advice as penalties can be serious. Don’t just assume you can make your holiday house a part of your SMSF.
Examples where you may breach superannuation investment rules include:
- Expensive artworks that are held as an investment inside your SMSF cannot be kept hanging on your walls at home, but instead must be stored in a reputable art storage facility and must also be insured.
- Staying in an investment property, or allowing friends or relatives to stay in the property, is also a big no-no if that property is held within an SMSF.
- Market value must be paid for everything held within an SMSF, meaning all transactions must occur at arm’s length. You can’t make a purchase from a family member at mate’s rates. If it is difficult to avoid such a clash, please seek professional advice.
If you wish to discuss SMSF diversification further, please contact our expert and award winning SMSF advisors.
Call (02) 4926 2300 or email us here at Leenane Templeton.