Super funds have been in the spotlight lately…courtesy of the Banking Royal Commission.
Industry funds came out looking OK.
The retail funds — those offered by banks and insurance companies — well, not so good.
Compulsory superannuation has been an absolute honeypot for institutions — industry and retail funds alike.
In an article covering the Banking Royal Commission’s examination of superannuation, ABC News reported…
‘A recent study by University of NSW economist Nicholas Morris estimated the financial industry had extracted around $700 billion in fees from the national savings pool since 1992, when compulsory superannuation was introduced.
‘Given the total pool is now worth just over $2.6 trillion, that’s an extraordinary proportion — almost a quarter.’
Obviously, people have to be paid for services.
Administration. Trustee. Funds management. Provision of advice.
And, don’t forget the marketing budgets.
The question is ‘how much is reasonable and how much is too much?’
And that’s subjective.
It depends on the services offered, performance delivered (in accordance with individual risk profiles) and the size of the account balance.
The Royal Commission has exposed a number of examples of ‘rich’ fees for ‘poor’ service and performance.
The one thing that might — and I say, might — come out of the Royal Commission is that institutions find a ‘sharper pencil’ when it comes to fees.
But from my experience with institutions, it’s best to apply a ‘high hope and low expectation’ mindset.
The third alternative in the superannuation business is self-managed super funds (SMSF).
The SMSF sector also comes in for its share of criticism…especially from the Industry and Retail funds that are losing members to the third alternative.
Some of the claims made against SMSFs include…
Fees are too high. In some cases, this might be true. But in the main, it’s a furphy.
When industry bodies tally up SMSF ‘fees’, one of the costs they include is life insurance premiums.
That’s not an ‘apples with apples’ fee comparison with public offer funds.
But, when it comes to holding onto a share of a $2.6 trillion pie, truth becomes a casualty.
Another claim is the abuse of the ‘Limited Recourse Borrowing Arrangement’ (LRBA) — by unscrupulous property spruikers — encouraging investment in over-priced residential property.
True. There are cases where members with small super balances have been lured into arrangements that are not in their best interest.
But — as I’ll show you shortly — these represent a tiny fraction of SMSFs.
And, the abuse is all but finished…
‘Borrowing in SMSFs: doors closing fast’
The Australian 6 Aug. 2018
‘SMSF borrowing not quite dead yet’
The Australian 15 Oct. 2018
The major banks are shutting down LRBA lending.
Last week, the ATO released its ‘ATO Self-Managed Superannuation Fund Quarterly Statistical Report June 2018’.
Here’s a couple of charts…
The ‘net establishment’ number has slowed over the past 12 months…but it’s still positive.
While the criticism of SMSFs has contributed to the slowdown, I suspect it is more to do with performance. While the public offer funds produced solid positive returns, members are content. When the bear market comes and returns go deeply negative, watch for an increased uptake in SMSFs…as members look to take back control of their future.
People with smaller balances are being ‘influenced’ to switch to an SMSF?
The ATO data does NOT support that claim.
Of all the SMSFs, funds with less than $50,000 have been a consistent 0.1% for five years.
It’s within this 0.1% of SMSFs where you might find the majority of those who’ve entered into dodgy LBRAs.
My guess is if you look at the percentage of members who’ve been gouged by institutional funds, you’ll find it’s a lot higher…but, that’s only a guess.
More than 92% of SMSFs have account balances in excess of $500,000.
And that’s why public offer funds are waging a propaganda war against SMSFs.
With their percentage-based fee model, members with higher account balances are the ‘cream on the institutional cake’. Extracting a 2% fee from $500k is far more lucrative than taking it from a $5k account.
Another statistic from the ATO report is…
‘The top asset types held by SMSFs, by value, are listed shares and cash and term deposits, making up 31% and 23% of total estimated SMSF assets, respectively.’
Where’s the rest invested?
Direct property accounts for another 16% (and this figure includes ownership of business premises).
The remaining 30% is spread amongst unlisted and listed trusts; managed funds and an assortment of other investments (collectables, precious metals, etc.).
The higher cash and term deposit weighting (compared to institutional funds) could be an indication of the more cautious nature of SMSF investors…as, according to the ATO, ‘84.3% of SMSF members are 45 years or older.’
People getting within range of retirement, or who are retired — with capital of $500k or more — tend to want to err on the side of caution. They’ve probably been through the downturns of 2000/01 and 2008/09 and know how devasting these can be to your money.
There’s another bear market coming and it’s shaping up to be far more ferocious than the previous two.
If you wish to be proactive and look to take control of your destiny before, and not after, the event, then here’s a brief summary of what to consider.
What are the SMSF ‘fors and against’?
The major ‘fors’ with 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…to see the full range of costs, go here to SMSF Review.
- In the case of a fund with $100,000, the fee equates to 0.7%–2% per annum (a touch too expensive at the higher fee level). However for a fund with $1M, it is a mere 0.07%–0.2% — this is an extremely low level of friction.
- You have 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 ‘against’ 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 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-complying 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 a SMSF want to be ‘cute’, invest in ‘edge of the envelope’ investments and generally be a smart a**e…do not go into a 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 or scams.
Should I hold individual shares, 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:
- Experience in investing
- The risk tolerance of each member
- Your individual investment bias — some people love shares others love property.
- Whether you are retired and seek a steady income OR accumulating funds and can afford to weight your portfolio to investments with potential for greater capital gain.
- Where we are at in the investment cycle e.g. having 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 you’ll pay (check this with your administrator).
One final thing…
One huge advantage that SMSFs have over public offer funds, is that cash deposits (held with Approved Deposit-taking Institutions) under $250k are GUARANTEED by the Australian Government.
Self-managed superannuation is an excellent option to take control of your financial future provided you have an interest in investments; good record keeping skills and sufficient capital (and/or future savings capacity) to reduce the annual admin costs to less than one percent of your fund value.
Editor, The Gowdie Letter