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Written by Matt Kirk Published: May 6 2020 Investments
Have you ever wondered why approximately one quarter of SMSF assets are invested in Australian bank deposits (i.e. deposits).
SMSF trustees might be holding deposits for the trust’s liquidity needs or as defensive assets for managing risk in uncertain times.
Such an approach is rational; however, SMSF trustees also have an obligation to attend to performance (1). For deposit allocations, does it mean investing in offers with the highest interest rate? The effective risks are similar after all.
Diagram 1.0 Portfolio Management Basics (2)
Diagram 1.0 above prompts the reader to consider why they allocate funds in the way they do. Consider the purpose of the allocation? Portions will be required for budgeted expenses while some will be at call just in case instant liquidity is needed to cover unexpected expenditure (3). The remainder should be made to work as hard as possible (4).
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Diagram 2.0 below shows the trade-offs SMSF trustees make when investing. Any two of the attributes can be present in an investment at any one time (5).
Shares offer liquidity and performance, but episodes like the Global Financial Crisis (GFC) demonstrate that liquidity can come at a heavy price. Most of us will recall the devastating impact on the lives of those who retired at the time.
Do you remember the mortgage and property managed investment schemes (MIS) that offered performance and capital stability until funds were frozen (i.e. redemption requests were suspended) in the wake of the GFC? Many sustained large capital losses when redemptions (i.e. liquidity) finally resumed (6).
Many hedge funds offered performance and capital stability until the GFC came along. Promises of performance come at a price (7). We all want performance, liquidity, and capital stability, but would a commercial entity ever offer all three? That’s why many SMSF’s have a prudent allocation to cash. Sound investing depends on sensible trade-offs.
Rest assured, deposit returns reflect lower risk (8), increased safety (9), and reliable liquidity. Here we define liquidity as the certainty your funds will be returned on a pre-agreed date. Much of investing is about picking the attributes that are most important. Australian bank term and at-call deposits offer reliable liquidity.
An SMSF trustee can be certain of receiving the full principal on a pre agreed date. Investing in the highest return is rational given deposit risks are similar.
Put excess SMSF liquidity to work
SMSF trustees take note – the variation in deposit rates matters.
Responsible SMSF trustees should seek the highest return possible for funds allocated to cash and term deposits if they believe bank deposit risks are similar.
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1. Superannuation Industry (Supervision) Act 1993 – Section 52 (6), (7), & (8).
2. The proportions are for demonstrating the concept only.
3. Superannuation Industry (Supervision) Act 1993 – Section 52 (2) (i) & (6) (iii).
4. Superannuation Industry (Supervision) Act 1993 – Section 52 (6), (7), & (8).
5. This diagram is for demonstration purposes only – the definitions of performance liquidity and stability can very on the writer and subtle differences can be meaningful or material in their application.
8.Risk can be defined as the possibility of an undesirable outcome such as earning less than expected, losing capital, or not having access to capital when it is due.
9.Insurance protection or additional collateral for example.