Is an SMSF right for you? I would like to give a balanced view on some of the key issues you should contemplate when exploring the option of an SMSF:
1. Understanding goals and strategy – The starting point for any retirement strategy needs to be having a fundamental understanding of your members’ goals and how your SMSF can enable them. Everyone is going to have different aspirations and liabilities for their retirement such as traveling, an annual income to live, aged care costs, helping their children or donating to charity. Understanding the concept of ‘liability matching’ and how your investment strategy can help you achieve your goals is crucial to a great outcome.
2. Understanding risk – Once you have an understanding of your goals and what you want to achieve, you need to understand your risk profile. To do this, you should ask questions such as how much risk you need to take (risk required), how much risk you can afford to take (risk capacity) and how much risk you would prefer to take (risk tolerance).
3. Investing your funds – Research shows a staggering 28 per cent of all SMSF investments are held in cash. This suggests people are likely still fearful of growth assets since the 2008 GFC and are trying to avoid risk. Being in markets can sometimes be scary (every decade we will likely have a major correction) but if you hold on, over the long term you should be rewarded. To manage your own money through an SMSF, you need to understand that no one knows if markets are going to go up or down tomorrow but over the long term there is a proven equity premium for simply being in global stock markets which you deserve to capture. Unfortunately, investors often do not capture this return as behavioural finance suggests our emotions and psychology hardwire us to behave in irrational ways like capitulating and selling all of our shares at the bottom of the market and buying when markets are going well and near the top.
4. Asset allocation – No one knows which asset class is going to outperform in any given year and the academic research has shown that it really is a lottery. However, 75 per cent of all Australian SMSF assets are held in direct property, Australian equities and cash, which shows a massive lack of diversification. In order to get great, risk-adjusted returns over the long term you should be ensuring that your SMSF is well diversified across Australian equities, international equities, domestic fixed interest, international fixed interest, property and cash to capture the different premiums on offer and spread your risk.
5. Understanding your role – People will often setup an SMSF on the advice of an adviser or by themselves without really understanding the time and risks associated with being the trustee. Before you set up an SMSF, make sure you have good governance in place and an understanding of what you will ultimately be responsible for. The costs of getting this wrong can be brutal.
6. Cost effectiveness – Once they do the due diligence, people are often shocked by the total fees they are being charged by industry and retail super funds, with the issue compounded by the perception around lack of personal advice. However, you also need to be realistic about the costs of running am SMSF including set-up costs, annual accounting costs, cost of your time, stockbroker commissions, professional adviser fees, cost of managed funds etc. My feeling from operating in the finance industry is that you need a minimum balance of $500,000 before you should contemplate an SMSF if cost is the main driver for your decision.
7. Flexibility and control – When operated effectively, an SMSF can give you a great sense of control. You have the ability to project manage asset allocation and investments, plan an individual tax strategy, strategise for your retirement and explore your own insurance options. As long as you have the expertise or are getting advice to ensure all of these things are being looked it, this can be very powerful. However, some people struggle with this extra workload and it can become stressful. You must be comfortable and be able to sleep at night knowing that your affairs are being maximised.
8. Do you need to get advice? – The reality is that most people who open an SMSF will be using a professional adviser whether it be an accountant, lawyer, stockbroker or financial planner. You should have an open mind with regards to getting advice and look for people who are going take the time to understand your goals and give great, independent advice free from conflict of interest. Take your time with this and speak to family, friends and trusted advisers to make sure you are making the right decision. When you meet with any advisers, make sure you are well prepared, do your research and write down a list of questions to ask them. Explore all the other options available to manage your super as there are low-cost structures where you can control the investments without opening an SMSF.
9. Borrowing and direct property in your SMSF – Over the past five years, the strategy of borrowing funds through your SMSF to invest in direct property has exploded. There are some strategic reasons when this can sometimes be a good idea such as buying your business premises or purchasing a high-yielding commercial property in this lower taxed environment. However, there are very few times in my professional career when this has actually been a strategy which makes sense when you are looking at someone’s entire position objectively and assessed all the available options. This is a complex issue with many spruikers and if you go down this path, I would recommend you get some independent advice. (Read Nestegg’s column for more advice on how to avoid spruikers)
10. Insurances and estate planning – Insurances are often forgotten about in SMSFs despite the fact that trustees are obliged to consider it each year. In particular, make sure that you are considering your life and TPD insurances through your SMSF as it is tax effective and should be an important part of most people’s overall strategy. You also need to understand how an SMSF fits in with your estate planning as these assets are dealt with separately from your will, need specific instruction and often have tax implications that can be minimised with the right strategy in place.
Steven Boyce, private client adviser, Capital Partners