Are you ready for an SMSF? Here’s a checklist to find out.
Self-managed super funds are increasingly popular but are not right for everyone
Recently, we released an episode on our podcast Investing Compass about my decision to switch super funds. Faced with a marked increase in fees, I jumped ship to something cheaper.
A question that naturally popped up was why I didn’t opt for an SMSF, especially considering their increasing popularity with investors. The ATO released figures for the 2021 financial year showing the largest increase in the number of SMSF establishments since the 2018 financial year. Why didn’t I join the over 25,000 new funds established?
The answer requires a bit of background. I’m currently 29, and I started working full-time seven years ago. Prior to that, I worked in retail jobs part-time while I was at university with default insurances eating away at relatively small contributions. Since joining the full-time workforce, I’ve salary sacrificed each year since graduation to build my super balance. I’ve recently reached an account balance of $77,000.
I’ve put that $77,000 in an industry super fund that has comparatively low fees and the ability to customise my exposure to each asset class. Both features are important to me because of the length of time I have until retirement. My long-time horizon warrants an aggressive asset allocation, but also higher fees will compound and negatively impact my end balance.
Both reasons, however, are also why SMSFs are attractive to investors. An SMSF is as customisable as anything in superannuation world. Most of the fees, excluding on the underlying assets, are flat fees. Depending on the balance, an SMSF may be the lowest cost option.
And it is this part of the equation that doesn’t add up at the moment for me. My balance isn’t enough to justify the flat fees inherent with a SMSF. A percentage-based fee model works best for my relatively small balance.
This leads to the first item on the checklist when assessing whether an SMSF is right for you.
1. The size of your balance
A report released by Rice Warner looked at when an SMSF made sense from a cost perspective. They found that around the $200,000 mark, it becomes competitive with industry and retail superannuation funds. At $500,000 or more, SMSFs are generally the cheapest alternative.
Flat fee administration costs do not suit smaller balances, where the fees are a larger proportion of your balance. The ATO estimated that the median operating expenses for an SMSF is $4,000. Applying that to my balance means I would be paying a whopping 5.2% in fees – and that’s before I even consider brokerage or fees on the underlying investment.
I've weitten an article on the true costs of for a SMSF which you can read here.
2. Let’s get personal – are you married?
The plus side to flat fee expenses is that the larger your balance gets, the smaller the fee is. SMSFs allow multiple trustees – up to 6 if you set up your SMSF with a corporate trustee. Although a hypothetical, if you have 6 people in your SMSF with $77,000, the fee drops to 0.8%. The most common scenario and set up is establishing an SMSF with a partner. There are no fixed rules for when you should set up an SMSF, but in my case, I would like to reach a balance of $250,000 before I set up an SMSF with my husband, who will contribute around the same amount.
It is also important to acknowledge though, that as you add people to your SMSF it adds complexity. The more people that are in the fund, the more retirement goals, dates, risk tolerance and risk capacity you must manage.
3. Do you have the time and willingness?
SMSFs are heavily regulated – they require a lot of work to remain compliant, including investment strategy documents, buy and sell trails, meeting minutes and notes – it is a lot of time and upkeep that does not go away. On top of this, superannuation is an everchanging landscape. The regulations change more often than you think, and it is your responsibility to keep on top of this.
Understanding whether you have the propensity to meet these obligations is vital. Are choosing your own investments really that important to you? Or are you happy to pass on all the paperwork, administration and compliance to a large industry or retail super fund and set and forget.
4. You have a keen interest in investing
SMSFs allow almost unlimited investment choice, including direct equities, funds, ETFs, antique cars, fine wines, and even Swiss Chalets (although be warned, you can’t enjoy them*).
It’s important that you have an active interest in investing because this is not a short-term commitment. It is a life-long commitment that involves keeping up to date with the legislative and regulatory environment, the market and why your investments are moving in the way they are, company announcements that could materially change the prospects of your investments – the list goes on.
If you’d rather spend your Friday night with your laptop shut with a glass of wine, outsource your management to an industry or retail superfund.
5. Can you handle it?
One of the key tenets of successful investing is separating your emotions from your investing and investing for the long-term.
Although you’re able to switch in and out of investing options in retail and industry superfunds, there is no obligation to log in and look at your investments. In fact, for many of us, we do not review our superfunds at all seeing as the money is locked away until retirement.
We’ve done some research at Morningstar into how much our irrationality as investors cost us. We call this the behaviour gap. The way we study this is looking at the return achieved by a fund and then looking at the return received by an investor.
The fund return is based on the underlying assets in the fund. The investor return is based on the inflows or outflows of actual investors deciding to buy into a fund or sell out of the fund. Those inflows and outflows have no direct impact on the performance, but the timing of your investments have a significant impact on the return that you get.
The gap is significant. My colleague Mark LaMonica explored this topic further in his article on how to earn 1.7% more a year than the average investor. We also explored the one thing we believe every investor needs to know in an episode of our podcast Investing Compass.
It’s important to recognise whether you will be able to separate your emotions from investing, because it could mean a detrimental impact to your total return outcomes. If you see yourself tinkering with investments at the slightest volatility in the market, an SMSF might not be right for you.
This is also not to say that managers do not have high turnover in their funds – but especially with the large superfunds, their size limits agility which is a welcome side effect. Managing large amounts of funds means that it is incredible hard to buy and sell assets without moving the market. Their impact must be managed prudently and helps to limit overtrading.
Ultimately, understanding whether you are ready for an SMSF is a combination of logical ticket boxes and a bit of self-reflection. It can be an onerous process, but also an enjoyable one where you are able to take control of your financial outcomes.
* The Swiss Chalet case is part of SMSF folklore where an SMSF purchased a Swiss Chalet and members used it for holidays and wine and dine friends and family.