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Should you diversify your SMSF?

Bryan Ashenden
February 06, 2018

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In investment terms, “diversification” means allocating your savings in a way that reduces your exposure to any one particular asset, asset class or risk. In turn, diversification can lead to a reduction in the overall level of risk or volatility associated with your investment portfolio.

Of course, the old adage about investments also rings true in that you cannot and should not use past performance as an indicator of future performance. Which means that if you diversify, it doesn’t guarantee that you won’t have volatility and doesn’t mean you are completely protected from market risks.

DIVERSIFYING THE SMSF

When it comes to an SMSF, the first thing you should be aware of is that it’s a requirement under superannuation law that you must formulate an investment strategy for your SMSF. In doing this, the law also requires you take into account diversification of the SMSF’s investments. 

Best practice would be to ensure that your SMSF’s trustee minutes clearly document any reasons as to the diversification approach taken.

The expression “don’t have all your eggs in the one basket” is the basis of diversification. To use an example, imagine if your SMSF had a direct property investment (e.g. a rental property) – depending on the total invested in your SMSF, a property could constitute a significant proportion of your portfolio.

While that property might be a valid investment, at one point in time you’d have to consider what  impact a downturn in the property market could mean for you and what would happen if you had to sell one asset at the wrong time in order to meet liquidity needs.

Of course, this single asset scenario is not the norm for most SMSFs. But it highlights the importance of diversification.

WAYS TO APPROACH DIVERSIFICATION

One view is to strike the appropriate balance between growth and income based investments. Your growth assets might be shares and managed funds, whilst your income based investments may be simple cash accounts, term deposits, or certain managed funds that pay regular income distributions, but offer little in the way of capital growth. 

This allocation, whilst a form of diversification, is really about your attitude to risk, and how much market volatility you are prepared to accept for the expectation of future returns (usually in the form of capital growth).

ASSET CLASSES

A second approach is to take it to the next level and look at asset classes. This can involve an allocation of investments across different investment types. Typically, these might comprise cash, fixed interest, property, shares and alternative (which could be anything that doesn’t neatly fit into one of the others).

You may also consider diversification within each of these asset classes. For example, diversification within the asset class of shares can be between Australian and International Shares, and could be between different segments of the market, such as financial, mining, retail, pharmaceutical and other stocks.

NO-ONE KNOWS THE FUTURE

No-one, not even the experts, can accurately predict when the high and low points will be. But if you’ve invested across, say, a range of different assets classes – from cash through to shares - you may not need to, because those asset classes don’t always move in the same direction at the same time.

So, when one asset is rising in value, another may be falling. Diversifying across different investments helps you to smooth out overall returns. You may miss out on some ‘upside’ if you’re not fully invested in the best performing asset class, but this can be compensated for by avoiding the potential impact of having all your funds in an asset experiencing a significant downturn.

Ultimately though, it comes down to the approach you want to take. As a concept, diversification sounds relatively simple and straight forward. But choosing which markets at the right time, and in the best way, can be challenging. Like with all SMSF matters, you don’t have to do it alone.  

You should consider seeking assistance from a professional adviser who understands not only investment markets, but also takes time to understand you, your SMSF and your goals. After all, success can really only be measured by how the choices you make impact on attaining your desired outcome.

Bryan Ashenden is head of technical literacy and advocacy at BT Financial Group.
Information current as at January 2018. This information does not take into account your personal objectives, financial situation or needs and so you should consider its appropriateness, having regard to your personal objectives, financial situation and needs having regard to these factors before acting on it. This information provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such. This information may contain material provided by third parties derived from sources believed to be accurate at its issue date. While such material is published with necessary permission, no company in the Westpac Group accepts any responsibility for the accuracy or completeness of, or endorses any such material. Except where contrary to law, we intend by this notice to exclude liability for this material.  Any super law considerations or comments outlined above are general statements only, based on an interpretation of the current super laws, and do not constitute legal advice. This publication has been prepared by BT Financial Group, a division of Westpac Banking Corporation ABN 33 007 457 141 AFSL & Australian credit licence 233714.

Published: Wednesday, February 07, 2018


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