An SMSF investment strategy: why is it necessary?
Generally, an SMSF can know what to invest in through an investment strategy. Furthermore, the fund will have a variety of choice of investment options when a good Investment Strategy is in place. SMSFs can choose to invest in cash only, but there are other forms of investments like property and shares, which are found both locally and overseas.
What is an Investment Strategy?
An SMSF investment strategy is simply a kind of financial plan that outlays how investments are made and managed based on the fund’s sole purpose.
Depending on the risk preferences, it will consider the current and/or future financial needs of every member of the fund.
An investment strategy that is in writing must:
- Be reviewed regularly so that it aligns with the purpose and circumstances of your fund together with its members.
- Weigh out whether it is necessary for the SMSF to hold insurance cover for every member.
Therefore, as you prepare, implement and review your investment strategy, you need to consider:
- Personal circumstances of each of the fund members, including their risk tolerance, age, income, retirement needs and assets that strategically fits into their objectives and circumstances.
- Risk and return expected when you make and hold SMSF’s investments with regard to cash flow requirements the fund’s objectives. The aim is to maximize returns expected from the fund as you minimize the risks.
- Liquidity of the investments that an SMSF possesses. The fund is required to ensure that it is capable of meeting its expected cash flow obligations, for instance, tax payment, regular pension payments, lump-sum benefits for the member exiting the fund, and superannuation surcharge liabilities of its members.
- Level of diversification within the SMSF. The funds need to ascertain whether diversification across several asset classes – e.g. shares, property, fixed interest in the long-term – is done appropriately for the benefits to be accrued. Over-exposure to specific assets or classes can expose members to certain potential losses.
- The ability of the SMSF to pay benefits to a member who retires as well as cater for other kinds of costs/expenses.
- Whether the fund should enable its members to hold insurance.
- Any other factor relevant to reliably value the proposed investments.
Important elements to incorporate into an investment strategy
- Property Investments
An SMSF can choose to either invest in a commercial or residential property locally or overseas. In order to buy this property, a trustee has the option to use cash or use a limited recourse borrowing arrangement outright. Note that any overseas property will require a foreign company to facilitate it.
When you decided to use your SMSF to invest in commercial property, you can acquire it, pay an arm’s-length rent amount from your business, then, later claim a tax deduction that will help fund your own retirement. On the other hand, if you invest in a residential property using your SMSF, you will not be allowed to utilize it for personal use.
2. Paying Expenses
There needs to be adequate liquidity that the trustees will use to pay the fund’s taxes, including; income, capital gains, contributions tax, PAYG, and GST. Also, to keep off the ATO from imposing penalties and interest, payment of other expenses – like administration cost, legal fees, stamp duty and brokers’ fees – should be done on a timely basis.
Since 2013, it is a requirement for Trustees to consider insurance in the SMSF annually. They can choose either to use a broker or take an online quote for the insurance facility. One of the common ones that Trustees could consider is the death and disability insurance needs of every member. As long as the fund complies with the superannuation laws, premiums gotten from insurance policies are generally tax-deductible.
The law requires SMSF to conduct an annual independent audit. In that perspective, it is the duty of the auditor to review the Trustees’ investments, to ascertain whether they are consistent with the outlaid investment strategy. They should be inconsistent, otherwise, if they are not provided in the investment strategy, it will be upon the auditor to highlight that issue.
When should a trustee formulate and review an Investment Strategy?
The right time that the Trustee needs to formulate the Investment Strategy is when the SMSF is being established. Remember, before any investment decisions are made, there needs to be an Investment Strategy in place. Therefore any decision that is made needs to fit within but not the strategy to be set to fit with current investments.
Any time the fund’s Trustees are contemplating about making an investment decision, they are supposed to check whether it is in alignment with the current Investment Strategy. A strategy needs not to necessarily restrict the Trustee on the kind of investments to make; it should be something that can be revised on a regular basis depending on the changing circumstances of the members.
Details of the specific individual investments that the fund intends to make in the future are not provided in an investment strategy. When preparing a strategy, such sort of granular details is not necessary since it will be set out in the fund’s financial plan. In addition, the specific percentage of the fund’s resources that will be allocated to each investment/asset class need not to be outlined in an investment strategy.
Documenting a particular SMSF Investment Strategy
Any investment plan needs to be well documented – neither in a short nor in a long way. Then, all the trustees will have to sign off that fund’s Investment Strategy document.
In case the trustees differ from the unanimous agreement, they may segregate SMSF assets into separate portfolios where appropriate Investment Strategies are documented for each. Trustees will be able to achieve investment control even though the SMSF Administration costs might increase.
What are the Prohibited Investments?
Therefore, Trustees need to ensure the following when formulating a strategy:
- investments are made on an arm’s length basis
- No loans are given out to either its members or their relatives.
- No breach of in-house asset rules occurs.
- Any investment complies with the sole purpose test.
- Restrictions are observed when acquiring assets from related parties.
- No grant security, mortgage or other charge is provided over the fund’s assets.
- No money is borrowed unless under rules found in s67A & s67B of SISA.
Getting professional guidance
Although it is crucial to be disciplined, it is usually daunting to set an effective investment strategy. Some people may feel that they are aware of everything, and they can do everything without getting guidance because it is a self-managed super fund. But, that is not the way to go about it when preparing an investment strategy. You need An SMSF accredited adviser. The advisor will help you formulate, execute and review your investment strategy as well as answer any pending queries.
The above article is information only and mot advice.