The recent downturn in the Australian share market has given the TV networks a bit of an angle for their nightly news. The predictable format is as follows: camera shot of older investor nervously looking at the monitor outside the Exchange Centre in Bridge Street, wondering if their money will be ok.
Next, we see the confident broker reassuring us that market corrections normal; and everyone should relax. The last scene presents a representative from the superannuation industry putting the downturn into perspective against the backdrop of the past two years of double digit performance.
Perhaps the retiree should worry. The market might be wobbling a bit before stabilising and resuming its uptrend.
But it may not. This could be the start of a very sinister bear market.
There’s an old market saying: ‘There are only two kinds of investors: Those who don’t know where the market is going and those who don’t know that they don’t know.’
The reality is the broker and superannuation representative can’t see what the stock market has in store for us. Their Pavlovian responses are a function of market conditioning and the inherent bias that comes with their association with the investment industry.
The prospect of a collapsing share market would not be in either of their interests.
Confidence and contentment are critical to the business of investing, especially when your business is making a percentage of other people’s money.
The following chart records the latest findings from the May 2014 Roy Morgan Research ‘Superannuation Satisfaction’ report. (Roy Morgan Research conduct annual interviews with over 30,000 people who have superannuation.)
- Satisfaction levels (confidence and contentment) wane when markets behave badly (2002-03 and 2008-09). Hence the need for the industry mouthpieces to keep the masses reassured.
- Not surprisingly, satisfaction is significantly higher amongst those who have control over their retirement capital.
As I mentioned earlier this week, there’s a steady flow of people migrating to SMSFs. The ATO estimates the number of SMSFs will nearly double (to one million) in the coming years.
Lower annual administration costs — thanks to technology — have lowered the barrier to SMSF entry. For example, a couple with $40,000 each in super can seriously consider the merits of a SMSF. This is a real game changer and poses a massive threat to the retail and industry funds.
SMSF pros and cons
The two major pros of an SMSF are the fees and flexibility:
- For those with larger fund balances, the dollar-based costs can be extremely economical. For example, the annual cost to administer an average (not too complex) SMSF can range from $700 to $2,000. For a fund with $100,000, the fee equates to 0.7% to 2% per annum (a touch too expensive at the higher fee level). However, for a fund with $1 million, it is a mere 0.07% to 0.2%. This is an extremely low level of friction. More on this later.
- The ability to control where your funds are invested (within reason). Conservative investors can access higher paying term deposits right through to higher risk taking investors accessing individual shares, property or precious metal investments. The ability to tailor your investment approach to your view of the world rather than accept an off-the-shelf balanced fund is a major attraction of SMSFs.
The major con is compliance:
- Freedom comes with responsibility. The ATO places a higher level of scrutiny on the accountability of SMSFs. A few bad apples have abused the investment flexibility (buying assets for personal use) and the ability to access their retirement funds prematurely. Therefore, it’s essential you maintain good records on the movement of funds within your SMSF. Contravention of the superannuation legislation can lead to the following:
- the trustee(s) can be suspended or removed and an acting trustee appointed;
- the assets of the fund can be frozen;
- the fund can be declared non-compliant for the relevant year(s) of income (this means losing the tax concessional treatment of contributions and income); and
- the trustee(s) can be prosecuted under the Civil Penalty provisions of Part 21 of the Superannuation Industry (Supervision) Act 1993 (SISA).
Believe me, the ATO is the last cage you want to rattle. Good record keeping, a well reasoned investment approach and access to qualified professional advice (on what you can and can’t do) should keep you on the straight and narrow.
Here’s my word of caution: If you or the firm promoting the establishment of an SMSF want to be ‘cute’, invest in ‘edge of the envelope’ investments, and generally be a smart a**e, do not go into an SMSF and ruin it for the rest of us. Remember the ‘Sole Purpose’ test — these funds are to be managed prudently for your retirement and not a plaything for people to indulge their hare-brained investment schemes and scams.
Now that that’s off my chest…
Should I hold individual shares and investment property in my super or concentrate on a certain asset class?
The type of investments you hold within superannuation will depend on a number of factors:
- Investment experience
- Risk tolerance of each member
- Investment bias (some love shares, others love property)
- Whether you are retired and seek a steady income OR you’re in the accumulation phase and can afford to weight your portfolio in investments with potential for greater capital gain
- Where we are at in the investment cycle, e.g., an overweight share exposure at the peak of the market in 2007 was not a great strategy
NOTE: The more active you are with your investment strategy (e.g. trading shares), the greater the administration fees could be, so check this with your administrator.
Where do most SMSFs invest?
As of March 2014, three main asset classes represent 76% of SMSF investments.
- Direct Australian shares – 32%
- Cash and term deposits – 28%
- Direct property – 16%
The other 24% is spread amongst unlisted and listed trusts (13%) and managed funds (5%). And an assortment of other investments (collectables, precious metals, etc.) make up the remaining 6%.
The ability to choose your own shares, term deposit(s) and property investment(s) is clearly a major reason for the growing popularity of SMSF.
Why retail and industry funds are under threat
Flexibility to choose your own investments (good or bad) is an obvious attraction for those weighing up whether to start a SMSF.
The other factor that usually tips the scale is cost.
Retail and industry funds all operate on a percentage fee basis. The percentage charged depends on the investment selection. On average, the fees can range from 0.8% to 1.5%.
For the purpose of the exercise, let’s assume a 1% fee is levied by the public offer fund. Let’s look at two members invested in the same fund.
A member with $20,000 pays $200. Whereas a member with $200,000 pays $2,000. They each receive the same performance, number of statements and newsletters. Yet, one pays $1800 more.
Now consider a couple, each with $200,000 in the public offer fund. Combined they are paying $4,000 per annum in fees.
The couple decides to establish their own SMSF with one of the low cost administrators and pay an annual fee of $700 (0.175% of their assets). In addition to the annual admin fee, there will also be any costs associated with buying and/or selling investments, which should not be too onerous on an annual basis for long term investors.
As long as public offer funds persist with percentage based fees, they can expect to see a fair share of their members with higher dollar accounts head for the exit marked ‘SMSF’.
The last couple of years have produced double digit returns. This explains why satisfaction levels within public offer funds have risen above 50%. Members are not overly bothered with fees when their account balance is ticking along nicely.
However, a scenario where we have a GFC MkII type event followed by a period of low growth will make life very uncomfortable for public offer funds. Justifying percentage based fees and negative performance to an angry mob would be a real hard sell.
Little wonder the public offer funds spend so much time and money lobbying government about the need to protect (with greater legislation) the ‘amateur’ SMSF investor from him or herself. The odd ‘amateur’ may blow themselves up, but on the whole, the data indicates SMSF investors tend to be careful with their own money.
What the industry is really trying to protect (and grow) is their share of the superannuation pie and keep the percentage based fee gravy train going.
Public offer funds do play an important role. There are a large number of people who do not have any desire or capability to manage their own funds. These members will always be ‘rusted’ onto the public offer funds. However, public offer funds are going to struggle to be a viable alternative for members with a keen eye for costs and an investment itch to scratch.
Self managed superannuation is an excellent option to take control of your financial future, provided you have an interest in investment, good record keeping skills, and sufficient capital (and/or future savings capacity) to reduce the annual admin costs to less than 1% of your fund value.
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