There are 3 main investment classes an SMSF can invest in, namely:
- Managed shares and share related investments;
- Bank and fixed term deposits; and
- Property
It is fairly straightforward what an SMSF can invest in. As long as the SMSF invests in something to genuinely provide for the retirement benefit of Members, 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. But there are certain rules around the types of investments an SMSF can acquire. Now, 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 cannot use your SMSF funds for your own purposes. In other words, you cannot lend money out to friends or family or run a business with your fund. But there is still a range of interesting investments you can make with your fund – as long as you follow certain SMSF rules.
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 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 you need to take the following into account:
- Risk and return: the risk involved in 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 for your SMSF. This can be with a traditional full service broker or an online broker.
Another good option is to use Separately Managed Accounts. As the transaction costs are low and it will assist you as a Trustee, in acquiring a diversified share portfolio.
You can use the following strategies in your SMSF for share investments:
- Covered Calls
- Warrants
- Dividend Stripping/Dividend Yield Play
- Franking Credits
- Portfolio Construction
- Asset Allocation
- Sector Allocation
- Diversification
- Alpha
II. Bank and Fixed Term Deposits
First of all, your SMSF should have an operating bank account. This is the main bank account for the SMSF. Superannuation Warehouse is not prescriptive on where to open up your bank account. Obviously, finding somewhere doing this at the lowest cost will get you the best deal for your SMSF. 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 high rates of interest can be earned, sometimes close to 7% per annum.
III. Property
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 a more detailed discussion).
Some FAQ’s about SMSF investments
Can I invest in racehorses with my SMSF?
In theory – yes, but in practice, the answer is 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.
Can I invest in property with my SMSF?
SMSFs are expressly forbidden 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.
How about jewellery, wine and art?
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 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 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.
