On the back of COVID-19, governments around the world have lowered interest rates to encourage more lending. While this is good news for businesses and home borrowers, it works to make it harder for investors nearing retirement to see decent returns.
Just six or seven years ago, investors could see up to 4% interest on a term deposit. Now that return is closer to 0%.
It’s a low yield environment. To combat this, investors should consider looking further afield at options that generate enough return to allow for pension drawdowns.
To achieve this, we recommend looking at your SMSF investment strategy, and ensuring it’s able to adapt to current market conditions.
Contact Liston Newton Advisory today to discuss your SMSF investment strategy. We’ll talk through your plans, goals, and current situation, and help you identify the best investment options to see you through the current low yield environment.
Understanding SMSF strategy
Under Australian superannuation law, your SMSF is required to have an investment strategy. The trustee of your SMSF is tasked with creating a robust strategy, reviewing it regularly, and managing the rollout of the strategy for you.
However, there isn’t a set document or investment strategy template that the trustee must follow. The strategy simply needs to take into account and outline the following:
- A list of the SMSF’s investments and their composition, including the diversity and level of exposure of each
- An analysis of the risks involved with each investment, both holding and realising the investment, against the SMSF’s objectives and requirements
- The investments’ liquidity in regards to cash flow
- Any insurance held for the fund’s members.
How to adapt your SMSF investment strategy to combat low yield environments
A defensive asset portfolio is typically made up of investments such as cash, term deposits, and bonds. These assets are generally considered safer investments than growth investments.
Defensive assets like these are better suited to SMSFs with older members, and those in retirement, as they usually experience less volatility than growth investments. There is less risk of them dropping in value when you choose to redeem them.
However, in the past year, the return on these assets has changed. Defensive assets are now producing little or no return for investors. This is forcing some investors to look at alternative investment strategy solutions.
SMSF investment strategy options
There are a number of self managed super fund investment strategy options that investors may consider instead.
If you can't generate enough income to cover your drawdowns, you can start (or continue to draw down) your investment capital. This means drawing down your cash reserves or selling investments and then withdrawing the cash income.
But be aware, there’s a trade-off here. While you’re not taking on the risk inherent in other investments, you may be increasing the risk of running out of money within your SMSF.
If you’re already drawing down an income from your SMSF, and you have other income streams, you may want to reconsider this approach.
If your SMSF is not structured optimally, you may find yourself drawing down on your capital when it’s already been heavily depleted by large market losses. This would expose you to greater risk than you might have planned.
When markets are rising and volatility is low, drawing down on capital to provide income can work. But in times of crisis, you may end up sacrificing more capital than you realise. This can make it difficult to regrow your capital in the future to meet your retirement funding goal.
A look at other lower risk investment options
In a persistent low yield environment, it may be time to consider other investment options. There are other options available than simply looking at cash, term deposits, and shares, that can form part of your SMSF investment strategy.
Fixed-Interest Exchange Traded Funds
Exchange traded funds are effectively a group of different individual investments, diversified across the market. Fixed interest ETFs are typically government and high-grade corporate bonds. This serves to limit their volatility.
When the bonds reach maturity you receive their face value in return, which helps preserve capital.
Exchange Traded Government Bonds
Australian Government Bonds are debt securities that have been issued by the Australian Government, which make them a low-risk investment option. They still deliver a regular income, are extremely liquid, and hedge against inflation.
There are two types to consider investing in:
- Treasury Bonds: These are medium-to-long-term securities with a fixed value and interest rate
- Treasury Indexed Bonds: When selling your bonds, you receive a pay out of the initial security price adjusted for CPI over the bond’s life.
Bank Hybrid Securities
Band Hybrid Securities provide either a fixed or floating return rate up to a set date.These are considered higher risk than typical bank deposits, as there’s no guarantee provided of the returns. But in a low yield environment, this risk may be what’s needed to deliver returns greater than 0%.
Consider moving to growth options
Considering a move to growth options for your SMSF investment strategy may be the best way to offset low yields. When managed correctly, this can be a suitable option, even for older retirees.
To do this in the safest way, it’s important to have a plan in place for the timing of your share sales. You should also ensure you have enough liquid assets to ride out any downturns in the market.
On a long term average (across seven or more years) shares have delivered around 9% per annum in total return. When managed correctly, this return can offset some or all of the capital you draw down from your SMSF each year.
Another potential option is to look at holding property in your SMSF. We do acknowledge that property isn’t suitable for all parties. But due to current low interest rates, it can be a way to access low rate home loans and use the low yield environment to your advantage. With correct long term planning, you may be able to use the expected income returns and capital appreciation of the property to build your SMSF, or reduce its decline.
The final word
The current low yield environment means investors need to be smarter about their SMSF investment strategies, if they want it to continue generating income. As such, it may be time to look at options you might not have considered before.
But if you do start considering other SMSF investment options, don't go it alone. An experienced adviser can provide the guidance and advice you need, and help you make investment choices that are still aligned with your financial goals.