It can be tempting for investors to ‘set and forget’ their investments and strategy. Some investors buy and sell assets, constantly reacting to short-term market movements. But what’s the right approach for asset allocation within an SMSF?
The right approach to buying and selling assets in a self-managed super fund (SMSF) can have a big impact on returns.
It’s tempting for investors to ‘set and forget’ their investments and strategy and make no changes to the assets in their fund over time. At the other end of the spectrum, some investors buy and sell assets all the time, reacting to short-term market movements.
So what’s the right approach when it comes to asset allocation in an SMSF?
Craig Banning, Director and Wealth Adviser with Navwealth, says in his experience, set and forget is not the right approach for creating wealth.
“We don't think this will work because of globalisation and the technology revolution. This is really going to change how we invest into the future. Investment funds will move to countries and markets that offer the best and most attractive return on capital,” he explains.
Banning says SMSF investors are starting to appreciate this and are reviewing the way they manage their assets.
“We're seeing DIY investors change the way they manage their fund. They are becoming what we call partial DIY investors, who appreciate it’s worth seeking advice about their fund in some areas.”
Another class of SMSF member Banning calls ‘outsourced investors’.
“They want to understand their investments. They can see how their portfolio is performing because they can compare it to the performance of an index like the ASX 200. If their assets are not doing as well as the index there’s a preference to invest in ETFs and index funds to ensure their performance at least matches the market,” Banning explains.
“We’ve seen investors really change their behaviours over the last 12 months. They question whether tinkering with their portfolio adds value and many think it doesn't. Trying to predict the direction of markets or stocks is difficult and SMSF investors appreciate that,” he explains.
Simon Russell, a director of Behavioural Finance Australia, has reviewed investment decision-making research into the impact that various strategies for buying and selling investments have on an investor’s returns. It’s a theme in his book, Applying behavioural finance in Australia.
As the book reveals, investors are driven by a range of decision-making biases that lead them to change investment allocations across a market cycle. While sometimes these decisions can be beneficial, on average they cost investors relative to a simple strategy of buy, hold, and rebalance.
Financial advice can help investors avoid this, but it’s not as simple as trying to buy at the bottom and sell at the top.
“If it was that obvious, sophisticated investors would do this and they should be making fortunes. But they're not,” says Russell.
Aside from market movements, transaction costs affect investor returns.
“Every time you buy or sell an investment a fee, buy-sell spread or taxes are likely to be involved. Investors calculating their returns can understate the importance of these relative to other investment considerations that better attract their attention. Stories about market booms and busts are more exciting than those about transaction costs and taxes!”
“There are also opportunity costs, which people don't consider. They tend to focus on real, materialised dollar consequences,” Russell explains.
He says rather than just focusing on the difference in the value of their investments between the time they buy and sell them, it’s important to assess the cost of what they missed out after making an investment decision.For instance, if an investor believes the market is going to crash and sells all their assets to convert them into cash, they may receive a paltry 2% return after a year.
“But what’s more important is to consider the return achieved if that decision had not been taken. They may have received a return of say 6% by staying invested, assuming the market did not crash. So if you're focusing on opportunity costs you would have made a loss of 4%, not a gain of 2%” says Russell.
Risk is the flipside of opportunity cost.
“Let’s say you think the market is going to fly, and you decide to reposition your investments towards growth or even speculative assets. The risk is your SMSF will end up with a risk profile that is not aligned to your ultimate objectives,” Russell adds.
“So it’s essential for investors to understand their goals and risk tolerances and set specific ranges around their asset allocations,” he adds.
For instance, you may ascertain the fund needs to comprise 70% growth assets to reach its goals. The investment strategy might set out that growth assets can make up between 60% to 80% of the fund, but unless your life circumstances or objectives change significantly, the allocation shouldn't go up to 100% and shouldn't drop to under 50% in growth assets.
“Sticking to a strategy avoids nervous investors panicking and going to 100% cash when markets are volatile,” Russell says.
SMSF trustees should ensure the fund’s assets are aligned to committed, long-term goals. This avoids the risk of SMSF trustees making big deviations such as going to 100% cash, which can lead to fees, taxes and opportunity costs that negatively impact returns.
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