The risks of an inadequate SMSF investment strategy

Introduction:

In the ever-evolving world of finance and investment, self-managed superannuation funds (SMSFs) have gained significant popularity among individuals seeking greater control and flexibility over their retirement savings.

However, the allure of managing one's own superannuation comes with inherent risks, particularly when it comes to an inadequate SMSF investment strategy. A well-defined and carefully executed investment strategy is crucial for the long-term success of an SMSF.

This blog aims to shed light on the potential pitfalls and dangers that arise from an insufficiently structured investment approach. By exploring the various risks involved, we aim to equip SMSF trustees with the knowledge necessary to navigate the complex investment landscape and safeguard their retirement funds.

What is an SMSF investment strategy?

An SMSF investment strategy is essentially a plan for how you want to invest the retirement benefits in your self-managed super fund (SMSF). It's important because it helps you achieve your investment objectives and retirement goals.

Your SMSF investment strategy should explain why you've chosen to invest your retirement savings in a particular way, such as in certain types of assets or industries. It should also outline how you plan to manage and monitor your investments to make sure they remain consistent with your goals.

It's a legal requirement to have an SMSF investment strategy and to review it regularly to ensure it's still relevant and appropriate for your needs. By taking the time to prepare a thoughtful investment strategy, you can help ensure that your SMSF is well-positioned to help you achieve your financial goals in retirement.

Investment strategy for SMSF: Why is it needed?

Investment strategy for SMSF is required for several reasons including:

• To ensure that the investment decisions made by trustees are suitable for the fund's purpose, within the legal framework of superannuation laws.
• To provide a guide to identify and set out an appropriate asset mix for the fund, which may include investments in growth assets such as shares and property, or defensive assets such as cash and fixed interest.
• To protect members of the fund from inappropriate investments, such as those that may expose them to undue risk.
• To ensure that the fund's trustees are aware of all relevant superannuation laws and regulations, including information about any limits or restrictions on certain investments.
• To help the trustees meet their obligations to act in the best interests of members.
• To outline a plan for reviewing and monitoring the investment portfolio on an ongoing basis, to ensure it remains appropriate and compliant with applicable laws.
• To provide guidance on how to manage any conflicts of interest between the trustee and members.
• To provide the trustee with direction when making investment decisions, to ensure they are consistent with their obligations as fiduciary.

What to include in your SMSF investment strategy?

An SMSF investment strategy is a written plan that explains how your retirement savings will be invested to achieve your retirement goals. It should be specific to your fund's circumstances and not just a repeat of the law.

Your investment strategy should consider the following factors:

• Each member's age,
• Employment status, and
• retirement needs,

This may influence the level of risk you are willing to take with your investments. For example, if a member is close to retirement, they may prefer lower risk investments to ensure they have enough money to retire comfortably.

Your investment strategy must also consider specific factors required by law. This includes:

• The risks and returns associated with your investments,
• How diversified your portfolio is,
• The liquidity of your assets, and
• The capacity of the fund to cover expenses, including member benefits such as lump sum or periodic pension payments upon retirement, and other associated costs.

You also need to consider whether to hold insurance cover for each member.

Remember, when developing your investment strategy, you can't just use a range of 0 to 100% for each type of investment. You need to explain how you plan to invest your money or why you need to use broad investment ranges to achieve your goals. You should also specify the percentage or dollar amount of the fund's assets that will be invested in each asset class.

Note: SMSF investment strategy should be tailored to your specific needs and goals, and clearly outline how your investments will help you achieve them.

Investment restrictions for self-managed superannuation funds (SMSFs)

You're free to choose what to invest in for your super fund, as long as it follows the rules in your fund's agreement and the law. Your investments should also be for the purpose of helping your fund members when they retire. There are some things you need to be careful about, like how much you invest in things related to your business and who you buy assets from. You also need to follow certain tax rules.

If you accidentally break the rules, the Australian Taxation Office (ATO) can help you fix it. However, if the breach is serious, the ATO may apply a penalty or even disqualify you as the trustee of the fund. It's important to make sure your investments are safe and your fund members are taken care of.

Identifying the risks of an inadequate SMSF investment strategy

Here are some of the risks associated with an inadequate SMSF investment strategy:

• Risk 1: Inadequate asset allocation:

  If you are not careful when selecting and allocating assets within your SMSF, you may be exposed to unnecessary levels of risk.

  For example:

  If a fund has too high of an allocation to one single asset class such as property it could be exposed to excessive volatility and potential losses. On the other hand, having too low a level of diversification may mean that the fund is not adequately exposed to growth opportunities.

  An important element of creating a suitable investment strategy for an SMSF is setting appropriate asset allocation ranges. These ranges should be tailored to your retirement goals and risk profile, and specify the percentage or dollar amount of the fund's assets that will be invested in each asset class. This can help ensure that your fund is diversified across different asset classes to reduce risk and maximise returns.

• Risk 2: Ignoring market conditions:

  When constructing an SMSF investment strategy, it is important to take into account the current and future market conditions. Failing to do so can mean that your investments are not adequately positioned for periods of market volatility or uncertainty, as well as missing out on opportunities that may be available at certain points in time.

  It is necessary to constantly monitor the markets and seek out potential opportunities that may be appropriate for the fund. This can include rebalancing portfolios to take advantage of changes in asset prices, or investing more heavily in certain sectors that are showing strong performance.

  In order to manage market risk it is essential to have a good understanding of the economic and geopolitical factors that can influence asset prices, as well as the ability to respond quickly to changes if necessary.

• Risk 3: Not considering the tax implications of investments:

  Taxation considerations should be taken into account when developing an SMSF investment strategy, as they can have a significant impact on the overall performance of the fund.

  For example:

  Investments in assets such as Australian shares are generally subject to capital gains tax when sold or transferred, whereas tax-free investments such as cash and fixed interest do not incur capital gains tax.

  It is also important to consider any specific taxation rules that apply to SMSFs, a significant impact on your fund's returns and liabilities.

  For example:

  If you choose investments that are not tax-effective for an SMSF (such as residential property), you may be liable to pay more tax than necessary.

  It is important to ensure that any investments held by your fund are structured in the most tax-efficient way possible in order to minimise your tax liabilities.

• Risk 4: Not understanding the legal and regulatory requirements:

  SMSFs are subject to a range of laws and regulations, so it is important that you understand these before developing your investment strategy.

  For example:

  There are restrictions on the types of investments your fund can make and how they must be held.

  It is also important to ensure that all transactions in relation to your fund follow the relevant legal requirements, such as ensuring that you comply with superannuation laws when making contributions or withdrawals from the fund. Failing to do so could leave you exposed to substantial fines and other penalties.

  It is therefore important to ensure that you understand all of the relevant legal and regulatory requirements before developing an investment strategy for your SMSF, and also to make sure that you are up-to-date with any changes in the laws or regulations.

• Risk 5: Ignoring insurance needs:

  When constructing an SMSF investment strategy it is also important to consider the insurance needs of the fund. Insurance can be a critical part of any financial plan, as it provides protection against unexpected events that could affect your fund's performance or leave you financially exposed.

  It is important to consider the types of insurance that may be appropriate for your fund, such as income protection, total & permanent disability cover, life insurance and trauma cover. It is also necessary to ensure that you have adequate levels of cover in place in case something happens that could put a strain on the sustainability of your fund.

  Finally, it is important to review your insurance cover regularly to ensure it is still appropriate for your needs. This could involve assessing if any of the cover levels need to be increased or decreased, or considering other types of insurance that may be beneficial for your SMSF.

• Risk 6 : Ignoring estate planning:

  When developing an investment strategy for your SMSF, it is important to consider estate planning. This involves considering how the assets within the fund will be distributed upon the death of a member and ensuring that all relevant documentation is in place.

  For example:

  You need to ensure that the fund's trust deed has been updated to reflect the wishes of all members and that a Binding Death Nomination is in place. This will ensure that assets are distributed as intended upon death, avoiding any potential family disputes or financial losses.

  It is also important to consider how you will manage digital assets such as cryptocurrency investments, social media accounts or online banking accounts. It is recommended that you create a document detailing the access details and any relevant information for these digital assets, which should be kept securely in case they are needed by the executor of your estate.

  By taking the time to consider estate planning when developing an SMSF investment strategy, you can help ensure that all your assets are managed and distributed as intended upon death.

• Risk 7: Poor record keeping:

  Good record keeping is critical for SMSFs, as it helps to ensure that the fund meets its legal obligations and operates efficiently. Poor record keeping can lead to significant problems and penalties, so it is important that you keep accurate records of all transactions made by the fund.

  For example:

  It is vital that you maintain accurate records of all contributions made to the fund and all expenses incurred. This will help ensure that you stay within the contribution limits set by superannuation laws and that any tax deductions are claimed correctly.

  It is also important to keep good records in relation to investment transactions, such as documenting the process used to select investments and the performance of those investments. This will help you track the fund's performance over time and identify any potential pitfalls or opportunities.

  By taking the time to maintain accurate and comprehensive records, you can help ensure that your SMSF meets all its legal and regulatory requirements.

Strategies to reduce the risk associated with SMSF investment strategy

Reducing the risk associated with a Self-Managed Superannuation Fund (SMSF) investment strategy is crucial to protect the retirement savings of members. Here are ten strategies to help minimize risk in SMSF investments:

• Diversify your portfolio:

  Spread your investments across different asset classes, such as stocks, bonds, real estate, and cash. Diversification helps reduce the impact of a single investment's poor performance on your overall portfolio.

• Conduct thorough research:

  Before investing in any asset, perform comprehensive research to understand its potential risks and returns. Stay updated on market trends and economic indicators that may affect your investments.

• Set realistic investment goals:

  Define clear investment objectives that align with your risk tolerance, time horizon, and retirement plans. Realistic goals help you avoid taking unnecessary risks or making impulsive investment decisions.

• Maintain an adequate cash reserve:

  Maintain a sufficient cash buffer within your SMSF to cover unexpected expenses, taxes, and liquidity needs. This ensures you don't have to sell investments at unfavorable times to meet short-term obligations.

• Regularly review and rebalance your portfolio:

  Periodically review your investment portfolio to assess its performance and rebalance if necessary. Rebalancing involves adjusting the allocation of assets to maintain the desired risk level and align with your investment strategy.

Conclusion

Investing in a SMSF can help individuals to save money for their future. However, the decision to follow through should be backed by in-depth understanding of the various risks associated with it. An effective investment strategy should include diversification, understanding of investment restrictions and objective assessment of expected returns based on predicted market conditions. Investing conservatively can help minimise risks while ensuring stable growth in the long run.

At CleanSlate, we advise investors to strive for a well balanced and suitable approach when developing their SMSF investment strategies. CleanSlate’s SMSF service can serve as an invaluable asset when considering important details that could go into such investment strategies due to our commitment to helping clients achieve their financial goals in accordance with ATO legislation.

With us you can rest assured that all your investments are compliant and protected from any potential legal repercussions. All this makes CleanSlate's SMSF service a must-have for anyone looking to create an effective and secure superannuation fund for retirement planning. Contact us today for more information.