Shares, Cash and Property are easily the three most popular asset classes held by Self-Managed Super Funds in Australia. Over 70% of the average SMSF holdings are divided into these three categories with the remaining percentage split up into managed funds, trusts and other smaller asset classes.
Let’s look at the three main asset classes so you can have a better understanding for your own investments.
At the outset, we should point out that running a SMSF need not be difficult but there are responsibilities and obligations that go with having one. The Trust Deed and the Investment Strategy of the Fund are essentially the rules of the Fund and these set out the types of investments an SMSF can invest in.
Shares are the most common investment choice for SMSFs and they can be broken down into Listed Shares and Unlisted Shares. An SMSF can access shares in a number of different ways depending on the risk profile of the Trustees. For example, the shares could be purchased directly via a Broker or purchased as part of a Managed Fund investment.
Purchasing Listed Australian shares that pay fully franked dividends may be an attractive option for an SMSF from a tax perspective, especially if the Fund is in pension phase and is taxed at NIL.
An SMSF can also purchase shares in an unlisted public company or a private company. Care should be taken to purchase shares in this arrangement from entities unrelated to the SMSF to avoid any restrictions being placed on the investment.
It’s important to understand that Shares can be volatile from a risk perspective but they do provide a proven avenue of growth which is essential for a SMSF. Shares are also quite liquid in that you can sell them and recoup your money much easier than some other asset classes.
If you need to draw on the SMSF investments for income then shares are a sensible option.
A large number of SMSF Trustees have potentially created future problems by withdrawing funds from growth investments and moving their money to cash instead. Some Trustees believe it is safer to hold cash as their funds won’t lose value this way and there is a certain logic to it.
However, investing in non-growth assets, also called income assets, means you are effectively losing money after the effects of inflation, although it may not feel as though you are at the time. Even low inflation will have a serious effect on cash holdings.
It’s important for trustees to bear in mind that even though you can’t see the value of your fund going down on statements, it doesn’t mean that your purchasing power is at the same level.
In this low interest rate environment Trustees relying on cash in their investment strategy may find themselves disadvantaged. They might find that their fund assets will not grow and investment returns will be under an even greater strain with lower rates. There is a real risk that money held in bank accounts such as Term Deposits and the like starts losing value in ‘real terms’ after allowing for the effect of inflation.
To achieve a good investment return over time a steady income stream and a growth in value are both needed. It’s worth noting that cash does not have a growth mechanism so any money invested in cash raises the risk of a reducing income stream as the fund makes withdrawals to make pension payments.
Clearly, investing in cash may not be as good as many investors think.
More and more SMSFs are investing in property. The solid growth available to correctly positioned investment quality properties is eagerly sought by Trustees. The availability of rental income that increases over time along with the property value makes for a compelling argument to invest. Being able to leverage, or gear, the investment is also a positive benefit as long as the Trustees ensure the repayments do not have a negative impact on the fund.
Leveraging via a limited recourse borrowing arrangement (LRBA) opens up the possibility of adding a passive income earning asset into the Fund. Naturally, Bank lending criteria has a big influence on how much you borrow and the Banks also control the cost effect on the fund by increasing or decreasing the interest rates whenever they want. The rent plays its part by reducing the loan balance over time improving the equity held within the asset. Combining any surplus from the Superannuation Guarantee contribution and the rent, left over after the repayment, with an offset account can produce good results too.
Property though is not as liquid as either cash or shares but it is suited to long term growth strategies within an SMSF structure.
We can see that each of these asset classes has benefits and will fit into a strategy for long term wealth creation. How you set up the various amounts and percentages within the fund is another matter.
We strongly recommend discussing your strategies with one of our experienced Financial Planners so you can proceed with confidence.