The Australian Financial Review‘s Adele Ferguson has written an outstanding and thought provoking article focusing on the under-performance of the self managed superannuation fund sector (SMSF).
The numbers are large, and shocking.
The SMSF $700 billion sector represents almost a third of the total superannuation system.
According to the article, with my emphasis…
“Based on figures released in late April by Industry Super Australia (ISA), Australia’s army of more than 1 million self-managed super fund members have potentially wasted billions in life savings over the past few years due to poor performance.”
Over the five years to 2016, industry super funds earned an average of 8.2 per cent per annum.
By contrast, ATO statistics crunched by ISA showed…
- SMSFs with assets over $2 million earned on average 5.6 per cent
- $1 million to $2 million earned on average 4.5 per cent
- $500,000 to $1 million 3.7 per cent
- For balances below $200,000, average returns dropped into the negatives.
That is a shocking level of under-performance, particularly on the lower balances.
How SMSFs could be diddling themselves out of hundreds of thousands of dollars
To put some dollar amounts on the numbers, an SMSF with a $1 million balance earning 4 per cent per annum over 5 years would grow to $1,216,653.
The same SMSF earning 8 per cent per annum over 5 years would grow to $1,469,328.
That’s over $250,000 of under-performance in just 5 years. The same numbers rolled out to 15 years give an under-performance of almost $1.4 million.
No wonder the AFR article says, for less sophisticated investors, who have limited money, SMSFs can be “catastrophic.”
“The sector has inadequate regulation, limited transparency, weak consumer protections and an ability to use limited recourse borrowing, which makes them a target for dodgy property spruikers and other shoddy outfits.”
The pain starts now for leveraged SMSFs
With property prices now in decline, with some suggesting we should brace for a “slow-motion property crash,” and others saying Sydney and Melbourne house prices could fall by 15 per cent from their peak, the pain will only just be beginning for SMSFs which leveraged up to buy investment properties at the top of the market.
I for one would not like to be shelling money out of my SMSF in interest payments on investment properties when the purpose of the account is to accumulate and grow assets for retirement.
With Sydney rental yields already less than 4 per cent for apartments, and rental prices coming down, those property investors banking on future capital growth making up for today’s negative returns are in for a rude shock.
How picking your own stocks can lead to investment under-performance
Not all under-performing SMSFs are into investment properties. I’d imagine more are into equities, with many trustees likely picking and buying their own stocks.
Here, SMSF trustees often fall into two camps.
1) Blue chip stocks paying fully franked dividends.
The tax advantages, particularly for SMSFs, of fully franked dividends, are substantial. Not only does the SMSF receive regular income through dividend payments, but it also gets a tax refund on its franking credits.
The focus on companies only paying fully franked dividends can lead to investing under-performance.
Look no further than the popular bank shares. Over the past 12 months, the Commonwealth Bank of Australia (ASX:CBA) share price has fallen 10 per cent, and is virtually flat over the past 5 years.
The story is far worse for Telstra Corporation (ASX:TLS) — not only has it cut its dividend, with further cuts almost certain to come, but the Telstra share price has fallen over 40 per cent in the last 5 years.
Meanwhile, the top performing ASX 20 blue chip over the past few years has been CSL Limited (ASX:CSL). CSL dividends are unfranked. The CSL dividend yield is less than one per cent. Yet the CSL share price has gained over 200 per cent in the last 5 years. My guess is many SMSFs have missed out buying CSL shares.
2) Speculative stocks
The lure of getting rich quickly is enticing. But the boring reality is getting rich takes many years of disciplined, sensible stock market investing.
The mining stock about to strike it rich in Botswana. The tiny technology stock whose share price is soaring. The biotech stock that’s soon to find the breakthrough cure to Alzheimer’s disease.
Almost always such speculative stock market bets will end badly.
Most SMSFs will probably only risk a small portion of their portfolios on such bets. But $10,000 here and $20,000 there going to zero can significantly impact on your overall investment returns.
More so if you keep repeating the same silly mistakes over and over again.
SMSF investing make simple
I’d suggest most SMSFs would be better served leaving stock market investing to the experts.
I’d also suggest they keep it very simple, achieving company and sector diversification by investing across a small number of funds.
Equities (80% allocation)
40% – International shares: Vanguard Index International Shares Fund
20% – Australian large and mid-cap shares: Firetrail Australian High Conviction Fund
10% – Australian small-cap shares: Perennial Value Microcaps Opportunities Trust
10% – Australian small-cap shares: Macquarie Australian Small Companies Fund
Cash (20% allocation)
Take your pick, but Citibank has a good suite of products, including an at call online savings account paying around 2 per cent interest.
Click here to read more detail on how you can be your own financial advisor.
As ever, invest for the long-term, reinvest your dividends where you can, and add more money to your SMSF where you can.
There are no guarantees when it comes to investing, but something as simple as a diversified portfolio of top performing funds should serve you well, over time.
As an added bonus, you’ll never have to attend a property seminar again.