Expanding SMSFs for the expanding family?
By Robert Wright /May 19,2023/
It has finally happened. Recommended by the Cooper Super System review in 2010, put forward in the Federal Budget four years ago by then Treasurer Scott Morrison and finally passed on 17 June 2021, the maximum amount of members allowed in a Self Managed Super Fund (SMSF) has expanded from four to six.
Despite the previous maximum of four members, the vast majority of SMSFs had only one or two members therefore this increase did not exactly stop the press. Yet the question remains, why would an SMSF want six members and what are the disadvantages?
The most logical reason for a fund to grow to six members is to gather a larger pool of assets to invest. A larger amount to invest could open up residential and commercial property investment, or other nonstandard assets that require a large capital outlay, such as fishing licenses or marina berths.
Greater diversification for what many would consider standard assets, such as shares and managed funds, could be better achieved with six members.
Additionally, if the SMSF is paying fixed accounting and administration costs, having six members would also result in a lower cost per member.
If a large family is running two funds currently due to the previous four member limit, the funds can now be consolidated. However, it would be a capital gains tax event for the fund that is being closed down. Therefore consideration should be given to the unrealised tax position for each fund when deciding which to keep and which to close.
The main disadvantage of a six member fund is just that, the six members. The larger the fund, the greater number of people who are involved in the decision making process and the greater number of people who have to agree. With a greater number of members there is also the greater likelihood that there will be a falling out or there will be a marriage breakdown that could result in the division of superannuation. This would be particularly detrimental if the six member fund was established to invest in one large illiquid asset.
The chances of one of these unfortunate events occurring magnifies with each additional member, so it goes without saying that six member funds and the accountants and advisers that assist them will see their fair share of grief and the financial consequences that result.
For current SMSF trustees who are considering taking advantage of this legislation change, a review of the trust deed should be completed and a corporate trustee should be appointed if one is not already in place.
The SMSF member limit increase to six is good. It provides more choice in a superannuation environment which is known for restrictions and adverse government legislation changes. Opening up self managed superannuation funds to six members does increase additional investment opportunities, however serious consideration should be given to potential ramifications prior to proceeding down this path.
If you would like to discuss establishing an SMSF with six members, or adding members to an existing SMSF, please contact your financial adviser.
Source: Bell Potter
Five charts on investing to keep in mind in rough times
By Robert Wright /May 19,2023/
- Successful investing can be really difficult in times like now with immense uncertainty around inflation, interest rates, issues in global banks and recession risks impacting the outlook for investment markets.
- This makes it all the more important to stay focused on the basic principles of successful investing.
- These five charts focus on critical aspects of investing that are insightful in times of market stress: the power of compound interest; don’t get blown off by cyclical swings; the roller coaster of investor emotion; the wall of worry; and market timing is hard.
Every so often the degree of uncertainty around investment markets surges and that’s been the case for more than a year now reflecting the combination of high inflation, rapid interest rate hikes, the high and rising risk of recession which has been added to in the last few weeks by problems in US and European banks. And all of this has been against the background of increased geopolitical uncertainties. Falls in the value of share markets and other investments can be stressful as no one wants to see their wealth decline. And so when uncertainty is high a natural inclination is to retreat to perceived safety. As always, turmoil around investment markets is being met with much prognostication, some of which is enlightening but much is just noise. I will be the first to admit that my crystal ball is even hazier than normal in times like the present. As the US Economist, JK Galbraith once said “there are two types of economists – those that don’t know and those that don’t know they don’t know.” And this is certainly an environment where we need to be humble.
But while history does not repeat as each cycle is different, it does rhyme, in that each cycle has many common characteristics. So, while each cycle is different the basic principles of investing still apply. This note revisits once again five charts I find particularly useful in times of economic and investment market stress.
Chart #1 The power of compound interest
This is my favourite chart. It shows the value of $1 invested in various Australian assets in 1900 allowing for the reinvestment of dividends and interest along the way. That $1 would have grown to $246 if invested in cash, to $997 if invested in bonds and to $781,048 if invested in shares up until the end of February. While the average return since 1900 is only double that in shares relative to bonds, the huge difference between the two at the end owes to the impact of compounding or earning returns on top of returns. So, any interest or return earned in one period is added to the original investment so that it all earns a return in the next period, and so on. I only have Australian residential property data back to 1926 but out of interest it shows (on average) similar long term compounded returns to shares.
Key message: to grow our wealth, we must have exposure to growth assets like shares and property. While shares and property have had a rough ride over the last year as interest rates surged, history shows that both will likely do well over the long term.
Chart #2 Don’t get blown off by cyclical swings
The trouble is that shares can have lots of (often severe) setbacks along the way as is evident during the periods highlighted by the arrows on the previous chart. Even annual returns in the share market are highly volatile but longer term returns tend to be solid and relatively smooth, as can be seen in the next chart. Since 1900, for Australian shares roughly two years out of ten have had negative returns but there are no negative returns over rolling 20-year periods.
The higher returns that shares produce over time relative to cash and bonds is compensation for the periodic setbacks they have. But understanding that these periodic setbacks are just an inevitable part of investing is important in being able to stay the course and get the benefit of the higher long term returns shares and other growth assets provide over time.
Key message: short term, sometimes violent swings in share markets are a fact of life but the longer the time horizon, the greater the chance your investments will meet their goals. So, in investing, time is on your side and it’s best to invest for the long term when you can.
Chart #3 The roller coaster of investor emotion
It’s well known that the swings in investment markets are more than can be justified by moves in investment fundamentals alone – like profits, dividends, rents and interest rates. This is because investor emotion plays a huge part. This has been more than evident over the last year with all the swings in markets. The next chart shows the roller coaster that investor emotion traces through the course of an investment cycle. Once a cycle turns down in a bear market, euphoria gives way to anxiety, denial, capitulation and ultimately depression at which point the asset class is under loved and undervalued and everyone who is going to sell has – and it becomes vulnerable to good (or less bad) news. This is the point of maximum opportunity. Once the cycle turns up again, depression gives way to hope and optimism before eventually seeing euphoria again.
Key message: investor emotion plays a huge role in magnifying the swings in investment markets. The key for investors is not to get sucked into this emotional roller coaster. Of course, doing this is easier said than done, which is why many investors end up getting wrong footed by the investment cycle.
Chart #4 The wall of worry
There is always something for investors to worry about it seems. And in a world where social media is competing intensely with old media it all seems more magnified and worrying. This is arguably evident again now in relation to uncertainty about inflation, interest rates and associated recessions risks. The global economy has had plenty of worries over the last century, but it got over them with Australian shares returning 11.7% per annum since 1900, with a broad rising trend in the All Ords price index as can be seen in the next chart, and US shares returning 9.9% pa. (Note that this chart shows the All Ords share price index whereas the first chart shows the value of $1 invested in the All Ords accumulation index, which allows for changes in share prices and dividends.)
Key message: worries are normal around the economy and investments and sometimes they become intense – like now but they eventually pass.
Chart #5 Timing is hard
The temptation to time markets is immense. With the benefit of hindsight many swings in markets like the tech boom and bust and the GFC look inevitable and hence forecastable and so it’s natural to think why not switch between say cash and shares within your super fund to anticipate market moves. This is particularly the case in times of emotional stress like now when much of the news around inflation, interest rates and recession risks seem bad. Fair enough if you have a process and put the effort in. But without a tried and tested market timing process, trying to time the market is difficult. A good way to demonstrate this is with a comparison of returns if an investor is fully invested in shares versus missing out on the best (or worst) days. The next chart shows that if you were fully invested in Australian shares from January 1995, you would have returned 9.3% pa (with dividends but not allowing for franking credits, tax and fees).
If by trying to time the market you avoided the 10 worst days (yellow bars), you would have boosted your return to 12.2% pa. And if you avoided the 40 worst days, it would have been boosted to 17.1% pa! But this is very hard, and many investors only get out after the bad returns have occurred, just in time to miss some of the best days. For example, if by trying to time the market you miss the 10 best days (blue bars), the return falls to 7.2% pa. If you miss the 40 best days, it drops to just 3% pa.
Key message: trying to time the share market is not easy. For most its best to stick to an appropriate well thought out long term investment strategy.
Source: Shane Oliver, AMP
Why investing for retirement is different
By Robert Wright /March 07,2023/
When you’re still employed and earning a salary, there’s money coming in you can rely on. In retirement, in the absence of a regular salary you’ll need to find a new way to secure enough income to cover your living costs.
Investing your money is one way to make the most of your savings and provide an income in retirement but if you’re expecting savings and investment earnings to help cover your expenses, it’s important to get your strategy right.
Why timing matters
When accumulating super for retirement, you can afford to be patient. With years ahead to top up your super, you can stay invested during falls in the share market and wait for markets and your assets to bounce back. For the few years just before and after retirement, it’s a different story. This period, known as the ‘retirement risk zone’, is the time when you have most to lose from a fall in the value of investments. Your super has likely reached its peak in value and you want to make the most of these savings for your future retirement income.
In order to protect your savings and provide you with income throughout your retirement, it’s important to be aware of three key risks:
1. Living longer
Australians are living longer than ever before. Life expectancy has grown by more than 30 years in the last century1. Living off retirement savings for 20-30 years or more introduces the very real risk of running out of money. So it’s no wonder more than half of Australians aged 50+ are worried about outliving their savings according to a 2019 National Seniors Australia survey.
We’re lucky that we live in a country that if your retirement savings run out; the Age Pension is there as a safety net but these regular payments may not be enough to maintain the lifestyle you’ve been enjoying in retirement. You could also be left with limited funds and options for aged care, if you should need it. That’s why it’s so important to make a financial plan early in your retirement so that you can help to protect your income now and in the future.
Inflation measures the change in the cost of living over time and represents an important and often underestimated risk to your financial security in retirement. Given your retirement could last 20 plus years, there’s a good chance your savings and income will be affected by inflation. At an average annual inflation rate of 2.5%2, a dollar today is worth roughly half what it was 25 years ago. Even this modest year on year rise in the price of goods and services can put you at risk of having an income that no longer covers your living expenses from year to year.
3. Share market performance
Share market performance is a risk for investors with exposure to investments such as shares, bonds and commodities. If you’re worried about market collapses similar to the Global Financial Crisis (GFC) in 2008, you’re not alone. A 2018 National Seniors Australia survey found that 7 out of 10 older Australians share your concerns.
Falls in the value of investments are impossible to predict and can make a big difference to income and financial security throughout your retirement. When investments earn negative returns, your retirement savings are falling in value. Crucially, if you also need to make regular withdrawals to pay for living expenses, it’s a twofold blow for your overall financial position in retirement. Less savings now means more potential for outliving those savings later in life.
Protecting your income and future in retirement
Diversifying your investments – balancing growth and defensive assets for example can limit the impact of market risks and inflation on your retirement savings. However, even with a well diversified portfolio, your super and Age Pension may not provide you enough income for your entire retirement. If you’d like the peace of mind that comes with a regular income for life, a lifetime annuity might be right for you.
Using a portion of your savings or super, you can invest in a lifetime annuity and receive regular income payments for life. It can act as a safety net ensuring that you will receive income for life, regardless of how long you live.
Talk to an adviser about the benefits of a lifetime annuity and whether it might be right for you.
 Australian Bureau of Statistics, Life Expectancy improvements in Australia over the last 125 years, 18 October 2017.
 Australian Bureau of Statistics, 70 years of inflation in Australia, Andrew Glasscock, 2017. Fig 2.
What are asset portfolios?
By Robert Wright /March 07,2023/
Building your wealth for the long term starts with a sound investment strategy; but with so many options outside your superannuation fund, from bonds to managed funds, where should you begin?
Understand your risk profile and timeframe
Almost every type of investment comes with some level of risk. There’s a risk you could lose money, as well as the possibility your investments won’t achieve your financial goals within the timeframe you need. As a general rule, the higher the risk the greater the potential return and the longer you should consider keeping that investment.
So first you need to understand what type of investor you are and recognise that this may change as you get closer to retirement.
When time is on your side, you may decide you can afford to take some calculated risks with your investment portfolio. That might place you at the ‘aggressive’ or ‘moderate to high growth’ end of the risk profile spectrum but if you’re planning to scale back on paid work soon, you may feel more ‘defensive’ or ‘conservative’ with your investment approach, to protect the value of the capital you’ve already built up.
To work out your risk profile, think about how you feel about short term fluctuations in the value of your investments. Would it keep you awake at night or would you be comfortable riding it out?
A market correction when you’re close to retirement could have a disproportionate impact on a larger portfolio so it’s also worth considering two risk profiles, one for your superannuation and one for your other investments.
What are asset classes?
An asset class is a type of investment – broadly speaking, these are cash, fixed interest, property or shares. Each has a different level of risk and return.
|Cash (defensive asset)||Fixed interest (defensive asset)|
|Investing in cash (such as term deposits) provides stable, low risk income (usually as interest payments). Traditionally, around 30 percent of assets are held in cash and term deposits. It’s a good idea to have some cash available at short notice and these investments usually have a short timeframe.||Investing in government or corporate bonds, mortgages or hybrid securities operate like a reverse loan – they pay you a regular interest payment over a fixed term. You usually hold fixed interest investments for one to three years.|
|Property securities (growth asset)||Australian and international shares (growth asset)|
|You can invest in property that is listed on share markets, including commercial, retail, hotel and industrial property. The potential returns can be medium to high but you may need to hold these investments for three to five years.||Shares (or equities) give you a part ownership of an Australian or international company. Your potential returns include capital growth (or loss) and income through dividends, which may be franked. Depending on the type of share, these are considered medium to high growth assets and you may need to hold them for up to seven years.|
All about diversification
Spreading your investments across a range of assets to reduce your risk is known as diversification – basically it lets you avoid putting all your eggs in one basket.
Diversification can reduce the volatility within your portfolio and the risk of a large drop due to any market downturn. Given it can also take time to sell certain investments (such as property), it’s smart to have short term as well as long term investments within your portfolio. There are no guarantees – diversification won’t fully protect you against loss but it can even out your returns.
Other ways to invest in shares
Investing in a managed fund gives you access to different equities, bonds and other assets, with a focus on a specific investment objective. Pooling your money with a group of investors lets you invest in opportunities that would otherwise be out of reach and diversify your risk. There are many different types of managed funds, with different risk profiles and investment approaches, including single sector or multi sector funds or index funds.
Review your investments regularly
It’s important to keep an eye on your investments to make sure your portfolio is balanced and you’re on track to meeting your financial goals. If you invest in a managed fund, you may only need to review it once a year. If you are investing directly, you’ll need to monitor market changes much more frequently.
It’s also worth getting advice from a financial adviser before you change your investment allocation, as selling assets may result in a tax liability. They can also give you an independent perspective on your investment goals and risk profile.
Source: Colonial First State