Why the angst about investment strategies?

A recent article in SMS Magazine here talks about the anxiety currently created by investment strategy requirements (and increased ATO and auditor focus) for accountants. I can see why many practitioners feel that way – but it’s wrong on so many levels that they do.

Let’s go right back to the fundamentals.

What’s the most important thing trustees of SMSFs actually “do” in running their own fund?

Surely it’s collecting, investing and then paying out the money. But the thing they think about most often (probably) is investing it. And I am confident that in the majority of the 600,000+ SMSFs, at least one person who belongs to each fund spends some time thinking about how their nest egg should be invested. That doesn’t mean they are doing it all themselves. Sometimes, the extent of “thinking about it” is finding a good financial adviser who recommends investments. And sometimes their “thinking about it” isn’t very good thinking and possibly not often enough – perhaps leading to dumb decisions or inertia. But they’re thinking something.

So why the angst over SMSF investment strategies?

It’s because legislators and even we in the industry have joined together a really important piece of work that I believe people are doing to varying degrees (deciding where to put the money) with a compliance exercise (writing it down). As soon as the “writing it down” part becomes the most important thing, we immediately dive to templates, standard asset allocations, checklists of issues to be considered etc rather than the actual important work of considering those issues.

It’s completely unworkable I know but I wish written investment strategies could be replaced by an interview with the trustees. The questions I’d ask (with some of the answers I’d probably get from the trustees) are:

The accountant, expert scribe: So, you’ve got 90% of your fund invested in this property. One of the things you’ve got to consider in an SMSF investment strategy is the risk of “inadequate diversification” which basically means having too many eggs in one basket. It’s not illegal to do it but you need to think about that risk.

Trustee: I can see what you mean – but on the other hand I think this property is a really good investment. I was able to get it quite cheaply and the yield is excellent. It’s in a good area and I’ve been looking at similar properties for a while, I think we’ve got a good one here. As we build up cash, we’re investing in other things like shares and term deposits that will spread out our risk a bit.

Expert scribe: OK – so you’re saying that you can see your fund isn’t particularly well diversified, you are planning to use cash flow to improve this over time and in the meantime you’re happy to accept the risk in view of your expectation of superior returns. Let me write that down.

Expert scribe: Now, what will you do if you suddenly need to pay out a large amount? You can’t sell “a bit” of your property? (One of the other things you have to consider when it comes to your investment strategy is liquidity – that means having the cash you need when you need it.)

Trustee: True. Hadn’t really thought about that. Now that I think about it, though, there’s only the two of us in the fund and we’re nowhere near old enough to take out our super. What sorts of things would make it necessary to pay out a large sum?

Expert scribe: Well, one of you could die. While you’ve also got life insurance in the fund, that would just make the deceased’s balance bigger, it wouldn’t necessarily give you enough cash to pay out their whole balance as a death benefit.

Trustee: OK – isn’t there any way to leave the super in there if one of us dies? I thought we could take a pension?

Expert scribe: You can – but only up to $1.7m.

Trustee: Ah, that makes sense. In that case, we’d use the insurance to pay out whatever we had to pay out in cash and take the rest as a pension so we can leave it in super. Even so, I can see that the fund’s investments might need to change if that happens because I don’t think the yield would be enough to make the pension payments forever.

Expert scribe: Quite right, in fact pensions are designed to draw down capital over time so at some point you might find you need to switch to something that gives you the ability to do that.

Trustee: Fair enough. And actually if we both died, couldn’t we just give the property to our children instead of selling it – they’re getting the money anyway.

Expert scribe: In fact you can pay benefits “in specie” – which means paying them out by transferring assets rather than in cash. So yes you can do that. There would be some tricky bits though – for example, if you paid it directly to your children and they were financially independent adults at the time, the fund would have to withhold tax. In your case that’s quite a lot of money. There are some things we can do there – let’s discuss with your estate planning lawyer. For now, I think what you’re saying is that while your SMSF owns the property, you will minimise the amount that needs to come out of the fund on death by drawing as much as possible as a pension. You will use life insurance proceeds to provide additional cash flow for large lump sum payments and if necessary will pay death benefits in specie.

Isn’t it a shame that accountants feel they can’t play this very valuable role? There was a lot of great advice and education in this exchange but no financial product advice at all. If you weren’t in this industry, you’d probably be surprised that any SMSF expert accountant would worry about having this conversation.

To be honest, I think their fear is misplaced. But I also think it’s entirely understandable that accountants feel that way. We’re throwing that blurred line between “financial product advice” and “advice and education in its most general sense” into an environment where accountants feel scrutinised at every step and paranoid about crossing the line. No wonder they want to be quite hands off when it comes to investment strategies.

This is exactly what we had in mind when we created our investment strategy document solution that helps accountants put “documenting the conversation” back into the hands of the trustees (part of our Super Toolkit, see here).

In my nirvana, an accountant would be guiding the trustee through the conversation with advice just like the above but the trustee would be choosing exactly what to say on the investment strategy document. They’d use our tool to help – the accountant would initiate a new strategy and use our unique “sharing” feature to hand the controls to the trustee who would then choose from a host of relevant potential paragraphs to document the thinking that backs up their strategy.

I really want that important conversation to happen – because all the knowledge the accountant can share (just like the above) really does shape the investment choices a trustee will want to make. But none of that means the accountant is advising on investments.

To see how our investment strategy and Super Toolkit can help your business, click here. Register for a one on one demonstration.