By: John Tutt
The process choosing the best mix of assets within your Self Managed Superannuation Fund is not easy. The best spread of assets will be determined by a number of factors such as age, attitude to risk and your long term goals. Generally, funds are invested across a number of assets such as Cash, Fixed Interest, Bonds, Australian Shares, International Shares, Property and alternative assets.
Apart from cash, the most widely invested assets are Shares and Property. So what is the better investment; Property or Shares.It is a widely debated topic however the debate within Superannuation has its own particular considerations.
As far as returns are concerned, there is not too much separating the two assets. Over the longer term they both return around 11% per annum.
To get a better idea of what it the preferred investment, lets take a look at advantages and disadvantages of each asset class.
Liquidity - An important issue for members and trustee's of an SMSF is liquidity. Members need to ensure that the fund has enough cash or liquid assets to fund expenses and outgoings such as tax, accounting/administration fees, property maintenance, management fees etc. Direct property is considered an illiquid asset, whereas shares generally have the benefit of being able to be sold, providing access to the proceeds in 4 days time (T+3). Shareholders can also sell a portion of their holding whereas property owners do not have that option. The issue of liquidity becomes even more important for retirees who need to make regular pension withdrawals. An example of a potential issue here might be a 61 year old client in pension phase with a $1 million fund balance which is made up of $20,000 in cash and a $980,000 property. If the minimum amount of income to be drawn is $40,000 for the financial year, in the event that the property became untenanted for a period of time the member could potentially find themselves in the position whereby they could not meet the minimum pension payment.
Tax effectiveness - there are arguments on both sides when it comes to tax effectiveness. There are a number of tax deductions available from residential property investments. These are often in the form of offsetting tax through deductions. However given Superannuation income is generally taxed at 15% in accumulation phase and 0% in pension phase these benefits are greater outside of super than within. Franking credits are available for some shares. Franking credits basically return you the difference between the company tax rate and your effective tax rate. Australian resident companies who pay 30% tax on their profits may impute franking credits to their shareholders on dividends paid from those profits. This means in super, you can get a tax credit or refund of either 15% or 30% depending on whether you have retired yet or not. These franking credits are very valuable in the low tax Superannuation environment. In addition, depending on the value and location of the property there may be Land Tax to pay which could potentially have a significant effect on the net rental yield of the property.
Volatility - Shares can be considered a highly volatile investment, meaning the value of your investment can move up and down quickly in a short period of time. However, this effect can be smoothed out by portfolio diversification and the length of time you remain invested. Volatility is often caused by uncertainty. We have seen some of the highest recorded levels of uncertainty and volatility in global sharemarkets in the last 2-3 years which would have tested even the most steely of investors.
Property can be considered to have moderate volatility, however it could be argued that this is largely due to the fact that the price of your house is not dictated by supply and demand on a daily basis and this price published daily. Factors which have a daily impact on share prices. By virtue of the fact that "average" long-term returns are very similar between shares and property, simple investment theory of risk vs. return would imply the risk of loss of capital from investing in shares vs. property would also be comparable. Australia has been fortunate that we have been broadly spared the same fate of most developed countries, whereby all asset prices were falling at the same time at a rapid rate, including home values. This is not to say that the Australian property market is immune to sharp corrections in value.
Loan to Value Ratio - The banks will generally lend at a higher loan to value ratio against a property when compared to shares. There is now the ability to leverage your Superannuation fund through use of a bare trust to access gearing to invest in a property within an SMSF. Superannuation legislation has moved to prevent such a strategy being implemented over a portfolio of shares. There are considerable costs involved in setting up such a structure within your SMSF so I suggest accessing professional advice before entering into such an agreement, being sure to look carefully at all the advantages and disadvantages and the overall viability of this strategy.
Ongoing costs - There are a number of transaction costs involved in direct property such as advertising, agent's fees, insurance, stamp duty, management costs, maintenance and repairs. Shares also have expenses involved including brokerage, investment management fees and performance fees.
Income Yield - The income return assets in superannuation become increasingly important as members move into retirement. Some bank shares are currently yielding dividends close to 8% pa plus franking credits. This may result in almost 10% pa after franking credits are taken into account. Residential property on the other hand traditionally returns around 4% pa in rental income before costs. The current variance between income yields available through some blue chip shares vs. property either implies that property values may be overheated, or share prices undervalued or a combination of the two.
Bio:
John Tutt is a financial adviser in Sydney. He is a member of the Financial Planners Association and a Certified Financial Planner. http://www.simplewealth.com.au/diversification-within-asset-classes smsf http://www.article-submission-express.com Article Submission by Article Submission Express
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