Alongside ensuring the SMSF is maintained for the sole purpose of providing retirement benefits to its members, SMSF trustees are obliged to consider diversification as a part of their fund’s written investment strategy.
Why diversification is important for SMSFs
Diversification aims to spread your SMSF’s investment risk so that if one asset performs below expectations, the performance of other assets can offset this and keep your fund on track to meet its investment objectives.
Diversifying across uncorrelated assets, such as shares and bonds, also makes it possible for investors to lower the volatility of the portfolio.
The idea here is that because these asset classes typically move in different directions in response to a certain scenario, such as an interest rate move, the portfolio can generate more consistent returns.
Investing across asset classes can also help with another thing trustees must consider – namely liquidity, or how easily the fund’s assets can be converted into cash.
The Australian Taxation Office (ATO) explains this by saying an SMSF “needs ready access to cash so it can pay administrative expenses, income tax and minimum income stream payments when they are due. So, it’s probably best not to have all your fund investments in fixed assets, such as property”.
What does a diversified SMSF portfolio look like?
For SMSFs the obligation to consider diversification is commonly expressed as a target allocation for each asset class and the acceptable range of variation from this target.
This then provides a relatively simple way to see how the portfolio aligns with the guidelines set out in the investment strategy.
Within large APRA-regulated super funds, asset allocation may change periodically throughout a member’s life depending on how close they are to retirement when reliability of income increases in importance.
Generally, however, while the proportions may change there will typically be a mix of cash, fixed interest, property and infrastructure, Australian shares, and global shares.
The chart below shows these asset classes and their sub categories, which represent different methods of gaining access to them.
How can you make sure you are diversified?
Accessing some of these asset classes can present challenges to individual investors and SMSFs because they may have minimum investment requirements, or other ownership restrictions that add complexity.
Two options providing easy access to diversification are managed funds and exchange traded funds (ETFs).
A managed fund pools money from multiple investors, then professional managers invest this in a variety of assets, which could be global or local shares, offshore property, infrastructure, or high-yield investments in line with a stated objective.
ETFs meanwhile aim to replicate the performance of a particular index or group of assets, effectively giving an investor exposure to an entire market or asset class.
For example, it is possible to buy ETFs that track:
- Specific share markets, for example the US, Japan, Europe or Australia
- Sectors or themes, such as small cap stocks or high yield stocks
- Commodities, bonds or property.
It’s important to understand the costs and risks associated with these sorts of products before investing and, as with all decisions related to your SMSF, consider how these align with the fund’s investment strategy.
It’s also a good idea to seek assistance from a professional financial planner, who can work with you to manage your risk and ensure your portfolio is diversified.