Why investment diversification is important for SMSFs

The right mix of investments for an SMSF will depend on very personal factors, including SMSF members’ age, lifestyle, attitude to risk and personal goals. And it’s not a case of set and forget – the SMSF trustees’ approach to SMSF investing may need to change over time as retirement approaches and priorities change. This article breakdowns exactly why investment diversification is important for SMSF’s.

Why is investment diversification so important to SMSF investing?

Diversifying an SMSF investment portfolio means having money invested across a range of different investments so that the SMSF is not over exposed if particular areas of the market fall in value. That might mean spreading money across different asset classes, regions, industries and investment managers.

Asset classes behave differently at different times – some asset classes will rise in value while others fall. Diversifying across different asset classes helps an SMSF to smooth out overall returns. On the one hand, this could mean missing out on some ‘upside’ if the SMSF is not fully invested in the best performing asset class. On the other hand, this could mean avoiding the potential impact of having all the SMSFs money invested in an asset experiencing a significant downturn.

What investment asset classes can be used to diversify an SMSF portfolio?

Diversification can be achieved through ‘asset allocation’. This is the way money is spread between different types of investments. It involves identifying the investments that match SMSF members’ goals and risk tolerance, then allocating a certain percentage of the SMSF portfolio to each asset class. It’s important to understand the benefits and risks of different types of investments.

Cash

Cash generally refers to investments in the short term money market including short term bonds issued by high quality companies or governments. ‘Short term’ typically refers to investments that mature in less than 12 months.

Cash has historically generated the lowest returns of the four major asset classes over the longer term and values may be eroded by inflation.

Fixed interest

Fixed interest assets (also called ‘fixed income’) include corporate and government bonds. They work like a loan from the investor to the bond issuer and offer benefits such as regular income returns at a set interest rate, over a fixed term.

Fixed interest investments generally involve lower risk than shares and property but sit higher on the risk spectrum than cash. Corporate bond investors risk losing all or part of their initial investment if the company issuing the security fails.

Listed property

Listed property trusts provide a simple way to invest in residential and commercial property without tying up a large proportion of money directly in real estate. Because investment is through the share market, investors can sell securities relatively easily if necessary (unlike direct property investments).

Like shares, units in listed property trusts can rise and fall in value. Returns are affected by fluctuations in the supply and demand for properties and consequential changes in rental levels, as well as by interest rates. Global property securities can also be affected by social, economic or political factors, differing tax structures in foreign tax jurisdictions and foreign regulatory requirements.

Shares

Shares, also called stocks or equities, enable investors to buy a slice of a public company. As part owners, investors may be entitled to a stake in the company’s profits in the form of dividends. As the company’s business grows over time, the value of the shares may grow and this can provide capital growth for shareholders.

Share prices can rise and fall and the payment of dividends and the return of capital are not guaranteed. Investors face the risk that a company, or the industry in which it operates, may not perform as well as expected or that there may be adverse changes in a company’s financial position.

How else can an SMSF portfolio be diversified?

Managed investments can be a solution for investors seeking professional expertise and a strong level of diversification. Managed investments take the hard work out of selecting which assets to buy and sell and when to do it – instead a professional investment manager does this.

Managed investments can invest across the full spectrum of asset classes, including cash, fixed income, property and shares. They can focus on a specific asset class such as shares, a particular industry, or even a specific country.

Managed investments can provide a level of diversification well beyond the reach of most direct investors. An Australian share fund, for example, could hold shares in dozens of Australian companies; a property fund can hold major assets like a commercial office block. However, along with the risks outlined above for individual asset classes, managed investments carry the additional risk that the investment manager(s) chosen may not perform as expected.

If you are concerned that your SMSF is not appropriately diversified, we encourage you to reach out to our team. We can examine your current structures and our expert team can make recommendations for a more diversified future as appropriate.