A Beginner’s Guide to SMSF Investment Strategy
As an SMSF trustee, you’re in control of the overall direction of your self managed super fund – and in essence, your financial future!
This means that you – along with other trustees if you’re sharing the SMSF – will have control of and responsibility for making good investments. It’s critical that you form an investment strategy for the fund that considers all of the members’ needs.
In fact, the law even says that the trustee of the SMSF has to make and follow a written investment strategy that is reviewed regularly. This is a big deal and the ATO has power to penalise a trustee who doesn’t adhere to the law. Also, the SMSF auditor will check the compliance of the SMSF’s investment strategy each year as part of the fund’s annual return.
If you’re unsure of how to form your fund’s SMSF investment strategy, you can get advice from a licenced financial adviser. But to get you started, we’ve created a beginner’s guide to SMSF investment strategy, so you can start to build your knowledge and understand what’s expected.
Step 1: Know your legal requirements
The trustee of your fund must legally create, implement and review (at least once a year) an investment strategy that considers:
Risk and return of fund investments, including the cash flow needs of the fund
Diversification of fund investments
Liquidity of fund investments, which is how fast they can be turned into cash, including the cash flow needs of the fund
Whether or not the trustees should hold insurance for one or more members
Whether the fund can meet its liabilities.
By law, you need to document an annual investment review, which is essentially a reviewed and updated version of your investment strategy.
Step 2: Understand risks and the return trade off
Different investments carry different risks, ranging from the conservative or low risk (where there’s a low risk of losing money, but lower returns over time), to the higher risk (which are more volatile but often yield higher returns in the long term).
The reason why this matters – and why you need to be aware of the nature of risk – is because it will impact you down the track. If you’ve recently retired (or are about to retire), you might opt for lower risk investments as you’ll be accessing your money sooner. ASIC reports that after our 30 to 40 years of work, we tend to live an extra 25 to 30 years after we retire – so it pays to do your research now!
Step 3: Diversify your investments
Have you heard of the saying, ‘don’t put all of your eggs in one basket’? Well the same applies for your SMSF investments. This is called diversification and it helps the overall performance of your fund should one of your investments perform poorly. However, some investments might actually do well when others aren’t, so it’s important to have a variety of investment options in your portfolio.
Step 4: Make sure the SMSF has enough liquid assets for the situation
Liquidity means how easily an investment or asset can be converted into cash. Cash is needed for the SMSF’s expenses and liabilities, such as annual fees, audit fees, bank fees, tax and minimum pensions payments for those eligible to take a pension from their SMSF. Cash is the most liquid asset because it is available to be used essentially immediately. On the other end of the spectrum are illiquid assets such as real estate, since it typically takes significant time and effort to sell real estate for cash. The investment strategy should consider whether the SMSF has enough liquid assets to meet its likely expenses.
Step 5: Make a decision on insurance
This is an important part of your investment strategy and it’s something to consider for yourself, either inside or outside of your SMSF.
Your fund can typically offer members insurance for an event so long as it’s in line with one of the following situations:
A terminal medical condition
If a member temporarily or permanently is unable to work.
Whatever you decide, it needs to be recorded in your investment strategy. It’s worth noting, however, that generally speaking trauma insurance can’t be held in an SMSF.