Investing for a rainy day: how much should your SMSF invest for the future?
Knowing how much to invest for a time in the future and how much to put aside for today is a balancing act that’s important to get right in a self-managed super fund (SMSF).
This involves investing in both liquid and illiquid assets. Liquid investments include things like shares and cash. Relatively illiquid investments include property, which takes time to sell, for instance.
As AMP financial planner Mark Borg explains, trustees’ main concerns should always be the members’ needs. This is of particular concern when members are of differing ages.
“Trustees should be mindful of the cash flow needs of the fund. This is of particular concern where the fund has real assets and borrowings as the ongoing expenses must always be allowed for,” he says.
A fund must always have sufficient funds to meet day-to-day expenses. As Borg explains, the need for liquidity has been reinforced by the limitations members have on contributing to their SMSF.
“Having insufficient liquidity to meet insurance, interest and expenses could cause an asset to be sold quickly and under circumstances that may not realise its full value. Knowing the potential requirements of the fund and planning for this reduces this risk,” he says.
According to Liam Shorte, financial planner and director of Verante Financial Planning, liquidity is important to take advantage of opportunities as they arise as well as to meet minimum pension payment requirements.
“No one wants to be forced, for example, to sell an investment property or shares to meet living expenses,” he adds.
When it comes to illiquid assets, Borg says trustees should consider every asset against the risk profile and needs of the members and the investment strategy of the fund.
“An illiquid asset may provide a higher income or potentially a higher gain and as such may present an exciting opportunity,” he adds.
Shorte agrees investors should hold illiquid assets. “These can be layered so that the best possible returns are achieved while managing the cash flow requirements of the fund.”
Before the financial crisis many people became too overweight in stocks and in listed and unlisted property because of the high returns. They routinely reinvested in these asset classes rather than rebalancing, as they believed the hype “this time it was different” and the world was on a wave of optimism.
“As a result when the market crashed in 2008 these investors did not have enough liquid assets to fund minimum pensions. Over the next two to three years they had to sell shares in companies that were worth less than 50 per cent of the face value in 2007,” says Shorte.
“Savvy trustees with liquid cash flow were actually able to pick up some of those stocks in capital raisings at very cheap prices. So liquidity provides confidence, opportunity and control,” he adds.
Investing over short, medium and long-term timeframes
Shorte explains it’s important to consider liquidity in terms of short-, medium- and long-term investment goals.
Over the short-term, it’s important to have enough liquidity to fund ongoing expenses and minimum pensions while also having a reserve for opportunities.
“In the medium-term, the idea is to match asset allocation and cash flow to your needs and avoid keeping too much in low return investments,” says Shorte.
“Longer term, manage inflation and longevity risk by having decent exposure to growth and tax-efficient income. Also estate plan to ensure your funds go to whom you want, when you want and in a way that suits your beneficiaries,” he adds.
As Shorte explains, trustees in accumulation phase need to keep some funds liquid for opportunities during market corrections and for expenses.
“Trustees in pension phase also need to ensure enough funds are available to fund pensions during volatile times,” he says.
The idea is to constantly monitor the balance of liquid and illiquid investments in the fund, keeping an eye on investment conditions, to ensure members’ needs are met now and in the future.