As trustee of your SMSF (self-managed superannuation fund), you would be aware of the responsibility you have to manage investments that will produce a comfortable income in retirement. You may have outsourced the fund administration to professionals such as SMSF Assure and engaged a licensed financial advisor to assist with investment decisions, but ultimately, the final responsibility for the fund performance is yours.
Apart from the usual market forces that affect any type of investment you make, there are some other, lesser known risks of which we should be aware. Three risks in particular are not directly linked to any investment category, which is most likely why they are often overlooked by SMSF trustees.
Risk No. 1 – Sequencing
The first is known as a sequencing risk and needs some explanation. You already know that investments perform better in some years than in others, but you may not have realised that the sequence in which these changes occur are just as important as the actual investment returns.
This particular risk came to prominence during the GFC (global financial crisis) when people close to retirement lost heavily as their share portfolios crashed. Those affected retired with less than they expected had the GFC not occurred, or in some cases, stayed in employment for much longer to recoup as much of their losses as possible.
Sequencing is all about timing. Losses made in the early stages of your working life can be recouped over time so that the fund balance is healthy at retirement. Those same losses later in life will likely have a profound negative impact on the balance available as members retire.
There is no single way to manage this sequencing risk. However, ensuring that the fund assets are diversified across several investment classes spreads that risk and lessens the overall long-term affect. Changing the asset mix over time to reduce volatility and having enough liquidity to avoid selling assets will maintain capital and keep the fund healthy.
Risk No. 2 – Liquidity
Liquidity then, or lack of it, is the next risk. A healthy SMSF needs cash on hand throughout its existence. Cash is required for administration, auditing, investment fees and other expenses. Fund members in the pension stage will need cash for pension payments or, in the case of bereavement cash to pay the family a benefit. Having cash in a high interest cash account is the best way to manage this risk.
Risk No. 3 – Underinsurance
Having the fund underinsured is the third major risk. Superannuation rules require fund trustees to consider insurance cover for its members, but some SMSFs choose not to do so. This places the fund at risk if assets must be sold, whatever the market conditions, in the event of the death or total and permanent disability of a fund member.
If members are insured against these or similar events, this insurance will most likely cover much of these expenses, leaving the fund assets intact and working to keep the fund balance healthy. These additional risks should be discussed with your financial advisor and plans put in place to manage them.