Top five self-managed superannuation mistakes to avoid
The Australian self-managed super fund market currently has 600,000 operating funds, holding a total of $700 billion - that's a lot of Australians calling the shots on their retirement!
While being self-directed has many advantages - control over asset allocation, performance and admin management - this also opens up many trustees to making common and avoidable mistakes.
As an SMSF trustee myself, here are my five mistakes to avoid.
- Spending too much time on admin and not on investment choice
Investment Trends has found that on average, SMSF trustees spend about 7.9 hours a month - almost two hours each week - managing their fund.
This is up from 6.3 hours per month in 2014. That's one Saturday each month dedicated solely to SMSF admin.
Time, or the lack of it, to dedicate to developing and implementing an investment strategy is one reason why many SMSFs are exposed to portfolio concentration risk.
According to Investment Trends about 55% of trustees have more than half their total SMSF balance invested in one investment type, a concerning trend of over-reliance and undue risk taking.
Despite the recent overall market performance and lack of diversification, SMSFs have a target return of 8%pa - somewhat unachievable if most of a trustee's time is lost on admin.
As a rule of thumb, SMSF trustees should spend most of their time researching, investing and managing overall performance.
For most, this is where the value-add is - the rationale for setting up an SMSF in the first place.
Lifting the net performance of a median-sized SMSF of $630,000 even by half a percent can provide investors with an extra $3150 a year - before compound interest.
This is more than double the cost of an average digital admin solution.
- Not setting an objective for the fund
It is vital to set an objective for the fund. How are trustees able to predict the growth of their funds for retirement otherwise?
The objective can be determined by working out when the fund will need to transition from accumulation to pension, and what the fund balance needs to be at that point to support the members for their remaining lifespan.
In simple terms, if a trustee retires at 65 and expects to live to 85, then the total dollar amount needs to factor in the annual spend of each of the members.
Working backwards in this sense can determine what the return and contribution mix needs to look like during the accumulation phase.
- Not separating discretionary investing from your SMSF investments
Many trustees treat their SMSF as an account for a "rainy day", investing in hobbies or pastimes such as classic cars, artwork or racehorses, rather than securing an adequate retirement income.
It's important to keep in mind the sole purpose test - meaning trustees need to maintain their fund for the sole purpose of funding retirement.
Legislation which came into effect last year also tightened the rules around collectibles. Investments into jewellery, artwork, wine and vehicles must be made for genuine retirement purposes, not to provide any present-day benefit.
So, while investors can explore alternative asset classes, it's best saved for discretionary investing which has no sway on your ultimate retirement outcome.
- Falling into the asset allocation trap
Asset allocation is the most important aspect in driving good performance.
It's often said that strategic asset allocation (SAA) is responsible for 80% of overall performance.
This means funds should be allocated to a variety of assets to create a well-diversified, but not over-diversified, fund which reflects what is occurring in the global economy.
The Australian sharemarket only makes up around 2% of the MSCI Index, which is a good and representative measure of the world market.
On average, Australian SMSFs invest about 30% in domestic equities and are overweight to cash, which is a concerning investment trend during the trustee's accumulation phase.
One of the key objectives of the fund should be to outperform relative to the consumer price index (CPI).
CPI is affected by the global economy, so investing with a global mindset will help achieve that goal.
- Being too active as you enter retirement
As you get closer to the transition from accumulation to pension, trustees need to look to reducing the risk and volatility of the fund's portfolio, by increasing the allocation to cash or fixed income investments.
This is usually at odds to what trustees do.
With more time as they enter retirement, trustees increasingly explore more investment opportunities and switch up asset allocation.
However, as we get older the asset allocation should be increasingly boring and stable to produce low-risk, reliable income.
So as you get older, think less about new investments and more about lowering the risk profile.