Source: Australian Taxation Office
2. Liquidity risk
Liquidity risk is simply the risk that your SMSF will be short of cash when you need it. For many investors, that can happen when their fund is asset rich but cash poor.
For example, consider the strategy of holding property through an SMSF - either a residential property or business premises. While it has many attractions, this strategy needs to be carefully managed to ensure the bulk of the fund’s value isn't locked away in an asset that can take months to sell. Even if you hold easily tradable assets, such as shares and bonds, a lack of liquidity could mean being forced to sell at a time not of your choosing.
That’s important, because SMSFs need to keep cash at the ready for a range of reasons.
First, you’ll need access to cash during the accumulation phase to cover the many costs of running your fund, including auditing, administration, advice, and investment fees and charges. You’ll also need cash during the pension phase to pay members regular pension payments or lump sums for holidays, large purchases and medical bills. Finally, if a member passes away or becomes totally and permanently disabled (TPD), you may need to find cash or sell assets to pay the member or their family a benefit.
If you’re short of cash and you’re forced to sell an asset when the market is down, you could lose out. Even if you have income-generating assets, such as high yield shares or a rental property, you can still find yourself short of cash when you need it - if you’re unexpectedly left without a tenant, for example.
That’s why it can make sense to keep cash on hand in a competitive interest SMSF cash account. It can also be important to ensure you have the appropriate type and level of insurance - which is where the next risk comes in.
Under superannuation rules, SMSF trustees must consider whether the fund should take out insurance covers for its members. There can be good reasons to do so.
Life and TPD insurance can help protect the financial future of SMSF members and their families. Just as importantly, it can also help protect the fund’s assets by providing liquidity if the unexpected happens. That’s because, if one of your members passes away or becomes permanently disabled, insurance can help you pay out their benefits without selling assets at an unfavourable time. So insurance is worth considering carefully, especially if your fund has more than one member.
Getting the right advice
As you can see, SMSF risk management involves more than simply choosing the right investments. A financial planner can help you consider all the risks of managing your fund, then put measures in place to protect yourself and your fund, now and in the future.