The three main asset classes that SMSF’s can invest in are:
- Managed shares and share related investments;
- Bank and fixed term deposits; and
Permissible SMSF investments are relatively straightforward. As long their aim is genuinely to provide retirement benefits for Fund Members, SMSF Trustees are generally heading in the right direction.
Many people dream of setting up an SMSF and filling it with exotic investments like artwork, classic cars and yachts. There are, however, certain rules as to the types of investments an SMSF can acquire. So, let’s take a look at what are deemed to be allowable SMSF investments.
The Sole Purpose Test
The rule of thumb when it comes to selecting investments for an SMSF is that the sole purpose of any investment must be to provide income on retirement for the Members of the SMSF. This means all the assets in the SMSF must have the potential to generate income by the time you retire. You can’t use your SMSF’s funds for your own purposes. In other words, you can’t lend money to friends or family or run a business with your Fund.
Running a Business in an SMSF
An SMSF is not permitted to run a business. Doing so is usually considered a strong indication that the Fund is in breach of the sole purpose test. An SMSF must be administered for the sole purpose of providing retirement benefits for Fund members. Investment decisions must be made for a future retirement benefit, not a current benefit.
Your SMSF must formulate an SMSF investment strategy rather than a business (trading) strategy, and any investment decisions must be in accordance with that investment strategy. Section 52 of the Superannuation Industry (Supervision) Act 1993 states that when formulating your strategy, the following must be taken into account:
- Risk and return: the risk involved in making an investment, and the likely return on that investment, taking into account your SMSF’s investment objectives and expected cash flow requirements.
- Diversification: the composition of your SMSF’s investments as a whole and whether the Trustees have considered the appropriate spread of risk across industry sectors, asset classes and countries.
- Liquidity and ability to discharge your SMSF’s liabilities: the ability of your SMSF to pay taxes, expenses and benefits as they become due.
When setting up an SMSF with Superannuation Warehouse, we provide you with assistance in the form of our investment strategy template.
I. Shares and Share Related Investments
Once your SMSF is established, you can open up a share trading account. This can be with a traditional full service broker or an online broker.
Another good option is to use Separately Managed Accounts – the transaction costs are low and it will assist you, as a Trustee, in acquiring a diversified share portfolio.
“Don’t put all your eggs in one basket” is all wrong. Put all your eggs in one basket and then watch that basket. It is easy to watch and carry one basket. It is trying to carry too many baskets that break most eggs.
“Don’t put all your eggs in one basket” is all wrong. Put all your eggs in one basket and then watch that basket. It is easy to watch and carry one basket. It is trying to carry too many baskets that break most eggs.— Andrew Carnegie, Carnegie Steel Company, 1835 - 1919
You can use the following strategies in your SMSF for share investments:
- Covered Calls
- Dividend Stripping/Dividend Yield Play
- Franking Credits
- Portfolio Construction
- Asset Allocation
- Sector Allocation
II. Bank and Fixed Term Deposits
First of all, your SMSF should have a bank operating account. This is the main bank account for the SMSF. Superannuation Warehouse is not prescriptive on where to open up your bank account.
Part of your investment strategy can be to put some or all of your Fund’s investments into a fixed term deposit. The great advantage of this is that capital is guaranteed (government guarantee) and a consistent interest income can be earned.
You can invest in residential or commercial property. If the SMSF buys a property outright, it’s similar to buying any other type of investment and will be done within the SMSF.
An SMSF can also borrow to purchase an investment property. To facilitate this borrowing, a Bare Trust is set up with a Corporate Trustee (click here for further details).
IV. Gold and Silver Bullion
SMSF also can invest in bullions such as gold and silver. However, Trustees need to be mindful of the Sole Purpose test, and the storage for these assets – commercial premises. For more info on the provider for this kind of investment, please see more at Ainslie Bullion.
FAQs about SMSF investments (click on the question to reveal the answer):
A: In theory, yes; but in practice, no. You could buy into a syndicate – but you’d have to be able to prove the syndicate wasn’t a business (because SMSFs can’t invest directly in a business). You’d also have to prove to the ATO that the investment was going to generate income for your retirement. If you’re a keen punter and you’re known within racing circles for your interest in horses, it’s unlikely the ATO would view your interest in a racehorse syndicate purely as an income-generating venture.
A: SMSFs are expressly prohibited from investing in the family home. They can, however, invest in investment properties – as long as the property is only used for investment purposes. This means Fund members can’t use the property for holiday purposes or rent it out to family members. The property generally needs to be managed by a real estate agent to satisfy the sole purpose test regulations.
A: You can invest in jewellery. However, if you want to satisfy the sole purpose test, you can’t wear it. Similarly, you can invest in wine through an SMSF – but you can’t drink it. SMSF investments in art operate in a similar way. You can’t display an artwork in your hall at home, but you can rent it to a corporation or an art bank whose business it is to rent out works of art.
Although you may be tempted to use your superannuation to invest in objects d’art and related items, the value of this type of investment is notoriously volatile and the market for these asset classes is generally pretty illiquid. Sure, have a little flutter with a small portion of your fund (within the law) but remember your SMSF is designed to support you in retirement. Investments for the SMSF should be in alignment with your investment strategy.
A: Yes, an SMSF can invest internationally. The first step you need to do is to ensure your Trust Deed allows these types of investments. Once the Trust Deed does not exclude the investments, the types of investments the SMSF actually holds are determined by the Investment Strategy, which is formulated in the Trustees’ capacities.
The Investment Strategy should reflect your objectives, risk tolerance, liquidity needs and the investments the Trustees intend to utilise. It can be changed as often as you wish, to suit your changing circumstances and to take advantage of new investment opportunities.