Strategies For Investing Your Self-Managed Super Fund

A self-managed super fund (SMSF) is a private super fund that you manage yourself. SMSFs offer more control over your investments and tax advantages, but they also come with greater responsibility and risk. Before setting up an SMSF, it's important to understand the rules and restrictions on investments, as well as the time and financial commitments involved. SMSFs can invest in a broader range of asset classes than traditional superannuation funds, including residential and commercial property, shares, cash and term deposits, fixed income products, and physical commodities. However, there are strict regulations around acquiring assets from related parties and restrictions on borrowing. Understanding your financial goals and risk tolerance is crucial when considering an SMSF.

Characteristics of Self-Managed Super Funds (SMSFs)

Investment property

Overview

Self-managed super funds (SMSFs) have become the single biggest asset class in Australia. Investing in property through an SMSF has grown in popularity in recent years, particularly since SMSFs can borrow money to fund a direct property purchase.

Rules

There are several rules that must be followed when investing in property through an SMSF:

• The property must meet the sole purpose test of solely providing retirement benefits to fund members.
• The property cannot be acquired from a related party of a member.
• The property cannot be lived in by a fund member or any fund members' related parties.
• The property cannot be rented by a fund member or any fund members' related parties.
• If investing in residential property, the property cannot be used as a holiday home.
• If investing in commercial property, the property can be leased to a fund member for their business, but it must be leased at the market rate and follow specific rules.

Costs

There are many fees and charges associated with the purchase, ownership and subsequent sale of a property in an SMSF. These include:

• Ongoing property management fees such as maintenance, rates, and insurance.
• Commissions payable to developers and real estate agents.
• Bank fees and loan costs, such as interest.

Borrowing

Borrowing to buy property through an SMSF is achieved through a limited recourse borrowing arrangement (LRBA). This means that the super fund must meet all loan repayments, and if it fails to do so, the lender can only take the property held in the separate trust as recourse and cannot access any remaining assets of the super fund.

Risks

There are several risks associated with borrowing to invest in property through an SMSF:

• Higher costs – SMSF property loans tend to be more costly than other property loans.
• Cash flow – Your fund must always have sufficient liquidity or cash flow to meet expenses such as loan repayments, insurance premiums, and other property expenses.
• Loan balance – A strategy must be in place to repay the loan in the event of illness, disability or death of members, or rental vacancy.
• Hard to cancel – If the SMSF property loan documents and contract aren't set up correctly, the arrangement cannot be unwound and the property may have to be sold, potentially causing losses to the SMSF.
• Possible tax losses – Tax losses from the property cannot be offset against taxable income outside the fund.
• No alterations to the property – You cannot make alterations that change the character of the property until the SMSF property loan is paid off.

Shares

Diversification and Risk Management:

• Start with a diversified portfolio: Invest in a range of market sectors, such as banks and resource companies, to spread risk.
• Blue-chip stocks: Consider investing in larger, well-established companies as a solid foundation before diversifying further.
• International shares or exchange-traded funds (ETFs): Diversifying internationally can enhance your portfolio's resilience.

Choosing a Stockbroker:

• Full-service stockbroker: Offers tailored advice, research, and analysis but typically charges higher fees ($80-120 per trade).
• Online stockbroker or brokerage account: A more affordable option, but you'll need to make investment decisions independently.

Selecting Shares:

• Long-term investment outlook: Focus on good-quality companies you believe in for the long term rather than short-term market fluctuations.
• Fundamental analysis: Examine the company's annual report, financial numbers, and management insights to assess its health and prospects.
• Market trends and macroeconomic factors: Consider the broader economic and market conditions that can impact share prices.

Planning Your Investment:

• Dollar-cost averaging: Invest a fixed amount at regular intervals to reduce the impact of market volatility on your investment.
• Start small: If you're new to investing, consider starting with a smaller investment and gradually increasing your position.

Placing Your Order:

• Market order: Buy or sell shares immediately at the current market price. You don't control the price but execute the trade quickly.
• Limit order: Set a specific price for buying or selling shares. Your order will only be executed if the market reaches your specified price.

Managing Your Portfolio:

• Long-term perspective: Investing is a lifelong journey; focus on risk management, investment time horizon, and the fundamentals of your investments.
• Learning and improvement: Even professionals face challenges, so embrace the learning curve and adjust your strategy as you gain experience.

Collectables

• Artworks (such as paintings and sculptures)
• Cultural or historical artefacts
• Motor vehicles and motorcycles
• Memberships of sporting clubs or social clubs
• Coins, medallions and bank notes (if their market value exceeds their face value)
• Rare books, manuscripts and folios
• Postage stamps and first-day covers
• Jewellery
• Wine or spirits
• Classic cars
• Boats

However, there are strict rules governing these types of investments. Collectables cannot be used by SMSF members or related parties and must be for genuine retirement purposes. They also cannot be stored or displayed in the private residence of an SMSF member or related party. The decision on where these items are stored must be documented and kept as a record.

In addition, collectables must be insured in the SMSF's trustees' name within seven days of being acquired and be valued at market value when preparing your fund's annual accounts and financial statements. They must also be valued by an independent expert if transferred or sold to a member of your SMSF or a related party.

Insurance

When formulating your investment strategy, you should carefully consider the insurance needs of your fund members. This includes assessing the risks associated with the investments you plan to make and determining whether insurance cover is necessary to mitigate these risks. For example, you may want to consider life insurance, permanent or temporary incapacity insurance, or other types of insurance cover to protect your members' interests.

It's important to note that SMSFs are not required to hold insurance for their members. However, the decision to forgo insurance should be made carefully and based on a thorough assessment of the risks involved. If you choose not to hold insurance, you should ensure that your fund has sufficient assets to cover any potential losses or liabilities that may arise.

Additionally, it's worth considering the personal circumstances of your fund members, such as their age, employment status, and retirement needs. These factors can influence the level and type of insurance cover that may be appropriate for your SMSF. It's also crucial to regularly review your investment strategy, including your insurance decisions, to ensure it remains aligned with the changing needs and circumstances of your fund and its members.

While managing an SMSF gives you control over your investment choices, it's important to remember that it also comes with significant responsibilities. By carefully considering the insurance needs of your fund and its members, you can help protect their financial well-being and ensure compliance with relevant laws and regulations.

Diversification

When determining your asset mix, it is important to consider your risk profile, which is influenced by factors such as your life stage, investment amount and regularity, and individual tax circumstances. While there is no one-size-fits-all approach to diversification, it is generally recommended that SMSFs invest in a range of assets, including cash, shares, and property, both locally and overseas.

In Australia, cash and shares are typically the most popular asset classes, each making up around 30% of an average SMSF's total assets. Property, including commercial and residential, is the third most common, with an average of less than 20% of each fund's value. However, it is important to note that other asset classes, such as listed property trusts, foreign property, and managed funds, can also be considered for ownership within SMSFs, subject to certain restrictions and professional advice.

To ensure compliance with regulations, it is essential to seek professional advice before making any investment decisions, as penalties for non-compliance can be serious. Additionally, it is important to remember that any investments made by your SMSF must be on a commercial 'arm's length' basis, reflecting the true market value and market rate of return.

Frequently asked questions