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Self Managed Super Fund (SMSF) Article
Practical SMSF Investment Strategy Issues

By Tony Negline.

This article may be out of date.

19th March 2008

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The ATO has made much of the need for Self Managed Super Funds to create an Investment Strategy.  Trustees have to do this in writing and then implement it.  They also need to regularly review it.

When trustees create or review their Investment Strategy they must look at each asset of their fund and consider the risks involved in making each investment, the likely return from each investment, the range and diversity of investments, any risks coming from limited diversification, the liquidity of the fund’s investments, the expected cash flow requirements and the ability of the fund to meet its existing and prospective liabilities.

The recent financial markets roller coaster ride will cause many trustees concern as to how they should go about considering all the above issues.

Some trustees will rely on a financial adviser to look after all necessary aspects of this problem.  Other trustees will want to look after the problem themselves and might be confused about where to start the process.

One place to start is to remember that any investment potentially provides two sources of return – income or capital.  The level and frequency of these different types of payments are the basic building blocks of any investment.

For example a company share will pay dividends.  The capital return occurs either through a deliberate decision of a company's directors or when the shares are sold.

$100,000 invested in the ASX 200 in March 1982 would have been worth over $1.46 million at the end of October 2007.  By early March 2008 it had fallen to $1.1 million.

When looking at sharemarket investments most investors focus too much on the movement on the capital value and not enough on the income (ie dividends) paid.  Over the 26 year period from March '82 to March '08, total dividend payments would have been over $530,000 before any tax issues such as franking credits are taken into account.  The average income return has been about 4% (before franking) per annum.

By way of comparison bank term deposits provide income.  The only capital payment occurs when the original capital is refunded at maturity.  If a super fund had invested $100,000 in 12-month term deposits between March '82 and March '08 it would still have $100,000 in capital but would have received $200,000 in income.  The average income paid has been about 8% per annum.

From this analysis one could conclude that shares have provided better total income and capital returns than term deposits.  Our 26 year investment period covers sharemarket booms (1987, 1995 – 2000, 2003 – 2007), busts (1987, 1994, 2001/02 and 2007/08) and periods of sideways movements.  Whilst this may be true, it doesn't take into account some of the other important factors that SMSF trustees have to think about.

Some super funds – especially those paying pensions – will need to carefully balance their income paying investments and their capital growth investments because better income returns tend to mean lower capital returns.

Trustees also have to consider the risk of each investment type?  The 25% drop in the Australian sharemarket since August 2007 has brought into clear focus that super fund trustees can loose their beneficiaries quite a lot of money especially if those assets have to be sold at a market low-point to pay a benefit, such as a death benefit.

Then of course with direct sharemarket investing there is the issue of picking stocks.  The recent turmoil has seen some company shares decline by over 90% whilst others have only fallen a few percent.

Recent research by Canberra University's NATSEM for the CPAs has found that "living standards in retirement fall by … 22 per cent for high income earners" following a 1% decrease in superannuation fund performance.

It is for this reason that careful trustees will think about how they would liquidate a fund in order to do all they can ensure that the sale price is maximized.  Some trustees employ some very clever strategies here such as delaying selling an asset or transferring ownership to a beneficiary as a benefit payment.  Principally this is done to ensure the trustees consider how their fund would meet its prospective liabilities.

Another fundamentally important issue to consider is the cost of buying, holding and selling an investment.  A big cost with any investment is government tax.  Super funds who typically own property have to pay stamp duty when they purchase it and, depending on which State, land tax each year.  Commercial property transactions often involve GST.  Capital Gains Tax may be payable when an asset is sold by a super fund.

Is our 26 year investment time-frame too long?  In real life it isn't and too few trustees think about how long their super fund will be around.

As depressing as it might sound to some, recent medical advances are ensuring that the vast bulk of us have a good chance of living to 90 years of age.  Today's children should be assuming they will live beyond 100 years.  Our super investments potentially therefore might need to last over 70 years from the time we start work until when we die.

The current crop of retirees need to assume their super funds will need to keep them going until their mid-80s.  In other words they may spend 20 to 25 years in retirement.

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