We've written a fair bit about how easy it is to setup and run a self-managed super fund (SMSF), including a series of articles dedicated to getting diversification and the asset allocation mix right.
But there's the potential that a large majority of SMSF trustees still have no idea and are wracking up losses that could see them enter retirement with virtually nothing of their next egg left.
According to the Australian Financial Review, Hostplus – the super fund that caters for employees in the hospitality industry – has found that members using its direct investment platform had accumulated losses of 5.1% between late 2013 and mid-2015 – compared to a 20% gain for its balanced super option. (Balanced super funds usually have a diversified array of asset classes).
Direct investment options allow super fund members to select their own stocks and how much of each they want, and trade as often as they like, within the confines of a super fund – rather than doing it through an SMSF.
I have no insight into the reasons for those losses, but safe to say it could be a multitude of reasons from having the wrong stocks, to over-trading, a heavy allocation to ASX-listed shares or something else.
If a large number of SMSF trustees are acting in a similar manner, many would be better off switching back to a low-cost, balanced super fund.
Simply buying shares for your SMSF is relatively easy. The hard part is getting your asset allocation right as well as your portfolio diversification. In this series of articles earlier this year, I outlined how an SMSF or retail investor could get close to replicating the asset allocation of a balanced fund, with all the advantages an SMSF brings.
Anecdotal reports suggest a large proportion of SMSFs have a massive allocation to the big four banks Australia and New Zealand Banking Group (ASX: ANZ), Commonwealth Bank of Australia (ASX: CBA), National Australia Bank Ltd (ASX: NAB) and Westpac Banking Corp (ASX: WBC), with most of the remaining funds sitting in term deposits and cash.
That's not a diversified portfolio.
The recent double-digit falls in the share prices of the big four banks would have gouged massive holes in portfolios comprised mainly of the big four banks. Credit Suisse estimates SMSFs have lost a combined $40 billion in the six months to September from their big four stakes.
And that why it's extremely important that all SMSF trustees need to understand asset allocation and diversification.
Diversification
Diversification means owning a series of assets with returns that aren't correlated. In other words, a fall in the share market has little impact on the value of bonds and fixed income assets. Similarly, owning international shares should have little correlation to the price movements of ASX-listed companies. Amazon's share price is hardly going to keep track with any of Australia's big four banks. In fact, Amazon's share price is up 17% since the end of March, while Westpac shares are down a whopping 17%.
Several studies have shown that a portfolio should generally hold between 10 and 20 stocks to be properly diversified. But that doesn't take into account the sectors they are in, where they earn their revenue and what external factors influence their earnings. Owning 10 mining services stocks or 15 gold miners isn't diversification either. Companies with offshore earnings, essential products, recurring revenues and in different sectors all need to be minimum considerations.
Asset allocation
Asset allocation is similar to diversification, but it's about getting the mix of assets in your portfolio right. It also means considering other assets apart from ASX-listed stocks. Owning 20 varied stocks on the ASX might be ok in most situations, but external factors affecting Australia might see your portfolio hammered.
That could mean considering investments in other asset classes such as international stocks, exchange traded funds (ETFs), listed investment companies (LICs), fixed income securities (some of which trade on the ASX), property, infrastructure and even private equity.
It might also mean that you might have a lower allocation to growth assets – generally regarded as local or international equities/shares.
Questions you want to ask yourself about your portfolio are things like:
- If Australia goes into a recession, how heavily is my portfolio exposed to that and how can I protect it?
- If the banking sector falls on hard times, where will my earnings and dividends come from?
- If the Australian dollar falls further, how will that impact the companies in my portfolio and can I benefit from that? Likewise, if the Australian dollar surges higher.
Remember your end goal. You are aiming to beat the professionals and retire with a handy nest egg that will see you comfortably through the remainder of your life.
That means keeping costs down, being properly diversified and understanding your asset allocation strategy.
Sure, many SMSF investors are comfortable holding a large position in Australian equities (myself included). But my SMSF also holds a sizeable proportion of ETFs purely exposed to international equities, not to mention several companies that make a vast majority of their earnings outside Australia. I also own LICs – to give me instant and wide diversification.
It's not perfect, yet and I'm aiming to improve my asset allocation. International equities are on my list as is a small allocation to fixed interest securities – and I don't mean bank hybrids or any of that sort of junk.
Foolish takeaway
If you don't understand diversification and asset allocation, there are plenty of resources available on the web to give you a better understanding. Getting educated in those two facets will more than likely lift your portfolio performance, not to mention doing a better job of protecting your capital during market downturns.
