Cash: Avoid the ‘set and forget’ approach
Cash is sometimes the forgotten part of a SMSF fund portfolio, taking a back seat to sexier asset classes such as shares and property. But it is important to take as much interest in managing the cash component of an SMSF as it is for every other aspect of the fund.
Greg Einfeld, a director of specialist SMSF advice firm Lime Super, says there are numerous reasons why SMSFs should retain a cash balance.
“The most common requirement for cash is to pay expenses and tax. SMSFs with debt will also need to make monthly loan repayments,” he says.
According to Einfeld many SMSF trustees like to have cash available to fund attractive investment opportunities that might arise at short notice.
“SMSFs in pension phase should also ensure there is enough cash to make pension drawdowns,” he adds.
Some funds will also hold cash as part of their investment strategy, especially if the trustees are conservative investors and/or believe that investment markets will fall.
When calculating the optimal amount of cash, Einfeld recommends considering whether money will come into the fund, such as contributions and investment income.
“An SMSF with regular incoming cash flow won’t need to hold much cash; it may be able to use its inflows to cover its outgoings. If fund members prefer not to hold large amounts of cash an alternative is to hold liquid assets such as listed securities, which can be sold at short notice.”
Jordan George, Head of Policy, SMSF Association says when it comes to the considerations trustees should make around cash holdings, it is important to position it within the fund’s overall investment strategy.
“That means you need to think about what members’ goals are and what they are trying to achieve. Members in accumulation phase are going to have very different goals to fund members who are in pension phase, for instance.”
George says SMSFs do tend to have a significant weighting in cash, which is sometimes unfairly criticised.
According to Australian Taxation Office data released in 20161 , SMSFs with assets valued between $500,000 and $1 million have on average 34.68% of their fund in cash, with this figure being 33.15% for SMSFs with assets valued at between $1 million and $2 million.
Says George: “Often SMSF members hold onto cash because it serves a specific purpose. It may give them the right amount of liquidity to pay their pension. Or they may be sitting out of volatile markets waiting for the right opportunity to come along.
“These are very valid reasons for having a higher allocation to cash. But the important thing is for people not to just set and forget their allocation to cash. It's essential to acknowledge that we are in a low interest rate environment. So investors are achieving a lower return on cash now than they may have in the past. As a result, some SMSF investors may need to move up the risk curve to achieve the required returns to meet their goals.”
However, George notes it is interesting SMSF cash holdings at the moment are at about the same level as they were before the financial crisis of 2007/2008.
“This puts most SMSF trustees in a really good position to be able to manage fluctuations in market volatility. It gives investors a really strong ability to manage their fund and then reinvest when the timing is right for them. It is important to remember there is safety in cash, especially when you are not sure where markets are heading.”
Nevertheless, George says it’s vital for SMSF investors to be able to take advantage of good investment opportunities when they arise.
“We are seeing evidence SMFSs are moving out of cash and looking to move more into exchange-traded structures and other managed investments, which can broaden their exposure to asset classes besides cash and Australian equities. What we are seeing is that SMSF investors are more and more looking for exposure to global assets to diversify their fund.”
It’s a natural evolution, given the low interest rate environment and the pick-up in global growth generally.
1 Australian Taxation Office, Self-managed super fund statistical report March 2016