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SMSF Diversification Strategy – are you on top of your obligations?

Are you questioning your obligations and requirements aligning with your SMSF diversification strategy? The Australian Taxation Office has recently mailed around 17,000 SMSF trustees with a ‘please explain’ letter. The target was a batch of funds that have more than 90% of their assets in a single asset class.

In many uninformed sectors of the media there was a tendency to report the issue in such a way that implied that having a single asset, or more than 90% of your SMSF assets in a single asset class, was somehow in breach of the regulations.

Nothing could be further from the truth and in typical fashion the real issue was distorted.

That doesn’t change the fact that the starting position for the ATO seems to be an assumption that you don’t know what you are doing.
I will quote two of the most successful investors of the 20th century on the topic of diversification.

“Diversification is a protection against ignorance. It makes very little sense to those who know what they are doing.” — Warren Buffet

“The wise man put all his eggs in one basket and watches the basket.” — Andrew Carnegie

I doubt that anyone at the ATO is going to claim to be a better investor than those two, so don’t be concerned if you get the ATO letter about diversification.

However, SMSF diversification strategy is generally accepted as providing a buffer against losses given that none of us can know the future with any great degree of certainty.  And, if one starts with the assumption that you don’t know what you are doing, you need to either be diversified, or explain why your lack of diversification is appropriate for the capital you have invested in your superfund.

An investment strategy is effectively the blueprint for dealing with your fund’s assets to ensure the SMSF’s investment objectives and members’ goals are met. It effectively puts in writing what you are thinking and intending to do. Checking that you have this document, and it aligns with your actions is where the ATO is going with their letter campaign.

Is your SMSF investment strategy meeting diversification requirements? 

An SMSF diversification investment strategy must take into account the following items:

  1. The risks involved in making, holding and realising the SMSFs investments, their expected return and cash flow requirements of your SMSF.
  2. The diversification and composition of your SMSF investment strategy.
  3. The liquidity of your SMSF investments, having regard to expected cash flow requirements.
  4. The SMSFs ability to pay your current and future liabilities, including benefits to the members.
  5. Considering whether to hold insurance cover for each member of your SMSF.

An important requirement for you as trustee of your SMSF is to have an investment objective and a strategy to achieve that objective in place, before you start to make decisions about how you want to invest your SMSF money.

Of equal importance is that the investment objective and strategy is not set in stone. You can choose to change the investment objectives you have set for your SMSF at any time.

It’s not uncommon for SMSFs with lower member balances to find diversification a challenge as there is limited money to invest. Nonetheless, you are still required to demonstrate that you adequately understand and mitigate the associated investment risks. You might also outline the growth expected, and how this will in future assist in adding diversification.

If you find yourself in this position, it is important your investment strategy reflects these risks.

For example, if you have invested in a large illiquid asset such as real property forming the majority of your fund, it is important to ensure your strategy reflects the concentration and liquidity risk associated with this investment. If that is a residential property you might need to put special focus on the future liquidity requirements of the fund, by estimating how long until pension obligations might arise, and whether you have an exit strategy in mind. Any special knowledge you have about the type of asset class, be that property or shares is also relevant to include in the investment strategy document.

Where you have in place an adequate SMSF diversification investment strategy that deals with these risks and can provide the necessary evidence to support your investment decisions, no further action is expected.

If your fund has not complied with its investment strategy requirements under superannuation law, you may be liable to administrative penalties being imposed by the ATO, as Regulator of the SMSF sector.

Your SMSF diversification strategy and investment needs to be reviewed at least once a year and your approved SMSF auditor will be asking to see it. Some trustees might find it frustrating when we ask for an updated investment strategy document from you, but as evidenced by this ATO campaign, they put a strong emphasis on the obligation to keep this part of your documentation up to date and relevant.

Here are some practical tips from the SMSF Association to help you stay on top of your SMSF diversification strategy obligations:

  • Put your investment objective and strategy in writing
  • Set an investment objective that you can comfortably achieve with the underlying investments you are comfortable to invest in
  • There is no template for an investment object and strategy, but make sure they reflect how you intend to invest your SMSF money
  • The investments you actually make must be accommodated by the investment strategy you have set
  • Most importantly, document your actions and decisions, as well as your reasons, and keep them as a record in order to demonstrate that you have indeed satisfied your obligations as a trustee in this important area

How Superfund Partners can help with your SMSF diversification

Superfund Partners can assist you document your SMSF investment strategy to ensure it is meeting diversification requirements.

Where you’ve received the ‘Is your SMSF investment strategy meeting diversification requirements?’ letter from the ATO we can also arrange for you to speak to a licensed SMSF specialist adviser who can review your current SMSF investments and provide recommendations.  Even if you consider yourself as self-directed, a fresh set of eyes is always valuable.

Take a look at this recent SMSF diversification strategy article: Is your SMSF adequately diversified?

If you have any questions, or would like to know more about how we can help, please contact us here, call us on 1300 362 943 or email info@superfundpartners.com.au.

May you be as successful as Warren Buffett and Andrew Carnegie!

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