What is suggested here is only a guide to some of the things you may like to consider.
- The first thing to consider is Risk, but not just the uncertainty of returns. Look at risk holistically and you will have a far clearer picture of where you are now, and how you might get to where you want to go. The first step is to determine what your objectives are for the fund. If the different member's objectives are diverse enough, it may be necessary to segregate assets and run multiple strategies.
- But primarily, always keep in mind that you're not investing and putting your assets at risk for the fun of it. So of course you have an objective in mind when you start the fund, and these objectives remain throughout the life of the fund. The flexibility that is inherent in an SMSF means that one of its greatest attributes is the ability to tailor its operations around your individual objectives.
- In knowing your objective, make sure you write it down. Make sure it is expressed in terms that are objectively measurable and make sure it has a timeline. For example, To have sufficient assets to fund a post tax retirement income of $50,000pa indexed to inflation by my planned retirement age of 60 years of age. At that point you have an objective that you can work towards, as opposed to something just as meaningful to you, but far less useful such as To have enough money to fund a comfortable retirement. This later example really doesn't let you know whether you're on track or not.
- Once you have the objective established you can work out how much your fund needs to earn over the period between now and when your objective matures. This is commonly known as your required risk, or required return.
- Next, you need to honestly assess just how much risk you are willing to expose yourself to. There is no right or wrong answer to this question. It's a personal choice and if your tolerance is lower than your neighbors, and they are taking risks and making returns you are missing out on, don't let it bother you. They may also suffer losses from time to time (which they are less likely to tell you about) that would make you sick to your stomach and sleepless for months. So be honest with this assessment and don't be afraid to run your own race.
- The next form of risk that should be considered is your capacity for risk. This is the degree to which the fund's performance can vary before your objectives are no longer obtainable or a significant change in strategy would be required.
- This is a form of risk that requires reasonably frequent review and clearly if a good year is had by the fund's investments then risk capacity increases. If a poor year is experienced the capacity is diminished.
- The aim of the investments over time is to progressively increase the funds capacity for risk as this would mean that over time the fund is in a safer and safer position in terms of its ability to meet its goals.
- Your investment strategy document would then state each of these factors along with an overall assessment of the level of risk to be targeted when making investment decisions.
- The next step is to look at how much direct effort you want to go to monitoring and implementing the investments of the fund. You are already expending quite a bit of effort running the fund. You may want to be very hands on when dealing with some asset classes, for example, you may like to hold direct shares, but you may not know much about property and so outsource this to a manager. Or alternatively, you may hold direct property but outsource the management to a property manager. These decisions can also be expressed within your strategy document, as they will be reflected in the type of assets you purchase.
- Based on your answers with respect to the risk, effort and lifecycle questions, you may choose to consider setting some limits on how much you will allocate to any given asset class. These should help fit your strategy to the risks you are willing to take, make sure that you have the money available to meet obligations to members, and to a large extent, protect you from making rash decisions about investment opportunities when everyone else is getting carried away on a wave of irrational euphoria.
- The final consideration in making it REAL is to consider the lifecycle of the fund and how the investments that are either currently held, or being considered, interact with these requirements. By lifecycle we are talking about how fund's will move from start up, long term accumulation, accumulation/pension mixed use, payment phase and through to wind up. These cycles can and will change in that a fund that commenced being in pension phase may, for example, introduce the kids as members, once again becoming a mixed use fund. But the investment decisions should keep these things in mind.
- For example, if the fund already has 50% of its assets in an industrial property, should it borrow to purchase another one if both members are about to start a pension? If it does make this investment, how will it ensure that lump sums and pensions can be funded? How can it protect itself against a member's death and the requirement to pay a death benefit? These kind of considerations are why the lifecycle stage of the fund should be considered within your strategy.
- Every investment decision should be made with reference to your strategy. Don't just make an investment because you thought it was a good idea. For example if you see a share you would like to buy, but you already have reached your maximum exposure under the fund's strategy, the question is, if this is such a good opportunity then what other share would you sell to make room for this new one. If the answer is none, then perhaps it is no better opportunity than the one's you are already exposed to and you should just let it pass.
- That way, you stay true to a well thought out and agreed to strategy and avoid jumping from one idea to the next, which just increases cost and generally decreases long term performance.
By actively working with your strategy, you will have a document that, just as the regulator would like to see, informs your choices and controls your risk. It will be a document that helps keep you focused on the things that matter. You will assess your investment decisions (and risk mitigation decisions like insurance) by asking better questions such as:
- whether the investment is likely to further your progress toward the stated objectives?
- Whether the investment fits within your broader attitudes and tolerances to risk?
- and whether it leaves your fund with potential liquidity issues depending on the phase your fund is in now, or will enter during the holding period of the asset?
Because you will have taken the time to formulate a strategy that suits the needs of the fund members, you will have an alignment between what each member needs and the actions of the fund. Remember, that if a particular member of the fund has significantly different objectives for their savings, you can segregate assets and run separate strategies for them. You must always remember that as a member you may like to do something within your fund, and as a member it may make perfect sense. But in your role as trustee you have to always consider the broader legislative requirements and restrictions that apply to the fund's ability to make investments.
