Your set-and-forget SMSF

PORTFOLIO POINT: Here’s a simple template to allocate your SMSF portfolio: easy to set up, easy to maintain.

Studies show that something like 40% of all SMSF assets are in held cash, a strong indication that a portion of SMSF fund operators are not terribly engaged with their own finances '¦ or at least refuse to put in the time.

I have seen many SMSFs that have their entire holdings sitting in a regular bank account earning very little interest. This is isn’t because the trustees hold a negative view on markets or are trying to time their investments, but because of inertia.

These investors are often looking for a conservative and easy-to-follow approach that allows them to generate good returns without being swamped by paperwork.

The good news is that if you are one of these investors, then you need look no further: here’s a plan for a DIY fund that’s simple and straightforward; monitoring it should take you about one minute a week, most weeks of the year. Just don’t expect to be blown away by its outperformance

As a financial adviser, I would always recommend you try to find a professional who can help you build a properly constructed portfolio, but let’s assume you are one of the thousands of investors who choose to go it alone.

Let’s also assume you want a portfolio that is properly constructed and invested, roughly allocated on a balanced approach with 50% in low-risk investments such as cash and fixed interest and 50% in market linked assets such as shares and property.

How much cash is enough?

Let’s start with cash. If you are in pension mode, then it should probably have a minimum of about one year’s worth of pension plus 3–5% of the fund. If you are in accumulation stage and unable to draw on the pension, then 3-5% is all you will need. This is solely for liquidity requirements such as accounting fees, tax and corporate actions.

So let’s assume a balance of $1 million within the fund and a cash allocation of 5%. That means $50,000 is kept in a bank account, normally your local bank. I prefer the Macquarie Cash Management account as a universal hub for an SMSF, but the choice of bank is not important.

Making the most of fixed interest

The next step is allocating funds into fixed interest. Working on the assumption that 50% is allocated to non-market-linked assets, then we would need to allocate another $450,000. The cleanest and most effective way to invest these funds is to use garden variety term deposits. So let’s spread that money over maturities ranging from one to five years, which means deposits of $90,000 each. At current rates we should be able to get close to the following:

1 Year $90,000 (CBA) 6%
2 Year $90,000 (NAB) 6%
3 Year $90,000 (ANZ) 7%
4 Year $90,000 (WBC) 6.5%
5 Year $90,000 (WBC) 7.05%

Tip: The big four banks will match each others’ rates, even the special ones, so all you need to do is shop around for the best rate, take it to your local bank and ask them to match it. You could conceivably hold all these term deposits with one institution as long as they are one of the big four, but it makes more sense to diversify.

Last month Westpac was offering 8% for five years, which is quite amazing. At 8% per annum without fees, fixed for five years, this is a rate that is equivalent to CPI or inflation rate plus 5% without any real risk. This could easily be considered one the best investments opportunities available at the time.

This strategy is called “riding the yield curve”. After 12 months the one-year term deposit will mature and then we roll this sum out for five years thus capturing all the rates on offer, both long and short. Thus once we set this up we only really have one maturity per year to deal with and we already know what we are going to do with it. Simple, isn’t it?

Cheap market exposure

The other 50% should to be allocated to market-linked assets; again, all we really want is the exposure without the hassle or the fees, so your best option is to buy everything – not each stock individually, but through an index fund or an ETF.

This means we are not trying to pick the good fund manager from the bad; all we are doing is trying to do is get the same return as the market for the smallest possible fee. Some of the best-known providers of index funds in Australia are Vanguard, State Street, Dimensional or Blackrock.

Many of these companies offer several index funds covering a number of markets but acknowledging the preference of most SMSF trustees for domestic shares, the fund could choose to invest solely into a fund based on either the ASX 200 or the ASX 300.

Either of these indices with provide you with exposure to the top Australian companies – all the major sectors of the market, giving the biggest weightings to the largest and most respected Australian companies as well as providing exposure to property via the largest property trusts such as Westfield and Stockland (note that property trusts only account for about 7% of the market at the moment).

Of course when you buy an index fund – which simply mirrors the performance of a particular index such as the ASX 200 – you are buying everything. You are perfectly aware that certain stocks are hopeless but knowingly buying them anyway because that is the only way to match the index.

If we are still working on the assumption that you have $1 million to invest then you would be looking to allocate $500,000 to a fund of this style. Given that it is such a large sum of money you can bring down the already reasonable management fee attached to these funds even further.

If you had just $50,000 to invest you could be expected to pay about 0.75% per annum in management fees for an index fund. But because you are choosing to invest your entire market-linked allocation of $500,000, you can access a wholesale discount that is usually only afforded to institutions and the very rich.

In most cases the discount rate for a product like this brings the annual fee down to 0.34% per annum, less than half the 0.75% charged to your average retail investor. This equates to about $1700 a year in fees on your $500,000 investment.

If the SMSF is in pension stage you may choose to opt for Vanguard Australian Share High Yield fund, which has a slightly higher MER of 0.4% per annum but favours the highest yielding shares in the index and produces income in the form of monthly distributions paid directly to a bank account.

Another option we have already mentioned are ETFs based on the Australian stockmarket, which are offered from both Vanguard and State Street, who offer products based on the ASX 50, the ASX 200 and the ASX 300. While they offer benefits such as being liquid or tradeable on the ASX and have fees that are often lower than the retail rates offered by index funds, you will also need to pay a commission on the purchase, which could be a hefty slice of your original stake.

What it looks like

So the investment portfolio of the SMSF would look like this:

Bank Account $50,000
Term Deposits $450,000 (Five x $90,000)
Australian Shares $500,000
Total $1,000,000

At the current rates, the investment portfolio would produce a running annual yield of 5.75% or about $57,500 per annum.

Further, if we assume that the 50% of assets that we have in the market do as well as the Australian stockmarket has over the past 40 years, then this should provide a growth return to the portfolio of something in the area of an additional 2.5–3.5% per annum for the whole portfolio. So the portfolio should return something like 5.75% in income and about 3% in growth each year.

While the strategy I have outlined is not what I would advise clients with particular needs, and the level of diversification is not quite as high as I would like, it is a very good start if your SMSF is currently sitting dormant in a bank account. This portfolio is easy to manage, easy to understand and should only require about two hours of paperwork.

Your only real obligation each year is to roll the term deposit; administration is easy with just three pieces of paper to give your accountant each year and it will probably work so well that it will outperform most of balanced funds for around $1700 a year or a total management fee of 0.18%.

Jamie Nemtsas is a partner of Lachlan Partners, the owner and distributor of The Investing Times.