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What’s the right trade off between income and growth in an SMSF?


Achieving the right balance between income and growth assets is a key consideration for all self-managed super fund (SMSF) trustees.



Assets that produce income typically include cash and fixed income investments as well as some infrastructure and commercial property funds. 

Growth assets include listed investments such as shares.

On one hand, most SMSFs require some exposure to assets whose underlying values are rising but that may not pay out substantial income. 

At the same time they will usually also require exposure to assets that produce income, but whose underlying values may not be growing as much on a relative basis as higher-growth assets.

This is a particularly difficult balance to get right the closer the investor is to retirement, and also once the investor has retired.

So how can SMSF trustees determine the right balance between income and growth assets throughout the life of the fund?
  
“The trustee should first understand the goals of the fund’s members when it comes to the right split between income and growth assets in their fund, then assess their experience investing and how they might react to volatility affecting the performance of their assets,” says AMP financial planner Mark Borg.  

This should give the trustees a guide as to how the fund members might react in a downward market. “With this information trustees would then understand the negative rate of return the fund can sustain,” Borg explains.  

Having done this work, trustees are now in a better position to make good decisions on how much of the fund they can expose to higher-risk investments. This will help them make good decisions in volatile times.

Says Borg: “Making bad decisions in volatile times is often the best way to destroy wealth. Investors should always try to sell high and buy low.”

Managing sequencing risk

Sequencing risk is one of the major variables SMSF trustees must factor in when deciding right the balance of income and growth assets for the fund.

Sequencing risk is the possibility there will be a major correction just before or just after the fund goes into pension phase and starts paying out more money that it earns. The risk is the fund’s value will be so eroded as a result of this event it may not have enough time to make up any losses once fund members are in retirement.

Borg says the simplest way to protect an SMSF from sequencing risk is to understand how much money the fund has to pay out, and then invest this amount in cash. 

Another important consideration around sequencing risk is when to sell assets, especially if the market suffers a correction.

“Selling growth assets at the wrong end of a cycle crystallises losses. Worse, these losses may be short-term, and once sold the potential for bounce back is lost,” explains Borg. 

He says when in pension phase it makes sense to have between 12 months and three years of pension requirements in cash or other low-volatile investments to guard against such an outcome.

Downside protection strategies 

Protection strategies can help a fund achieve exposure to growth assets without exposing the fund to too much downside risk.

For instance, when buying shares investors can also buy an option to protect against the share going down in value. 

“This may allow them to sell the share at a predetermined value in the future. But it’s important to understand options do cost money and their cost must be assessed against their benefit,” says Borg.  

It is also essential for trustees to have systems in place across the portfolio to ensure options do not expire inadvertently and leave the fund unprotected. 

There are a variety of instruments that can be used to let trustees know when an option is expiring, which are usually accessed through the online portal from which the option is bought. 

But it’s important to acknowledge options can be complex financial instruments and working with a professional who can guide you through this area can assist in reducing volatility and risk.

There are also financial products that offer built-in downside risk protection. But like options, these have fees attached that impact returns. It’s important to take this into consideration when assessing this investment opportunity.

The golden rule is to only invest in opportunities you understand.  By doing this, your ability to make good decisions in a stressed market increases.  

The right balance between growth and income assets in an SMSF will depend on the members’ goals, appetite for risk, age and available assets.

The mix will be different for everyone, and could change over time. So it’s worth assessing this balance on an ongoing basis to ensure the assets in the fund remain appropriate for members’ needs.
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