I'm too young to invest - aren't I?

28/09/2015

Welcome to Part II of our series on educating young adults about self managed superannuation and the things that go with it. Last month we talked about getting a sense for your super and we busted the myth of being too young to have a self managed superannuation fund. This month we will bust another myth – "I'm too young to invest, aren't I?"

Now that we all know that we have super, and we know that we can do different things with it, the next step is to think about what? And when?

First things first - why wait!

You wouldn’t let someone else decide what to do with the money in your or your young adult’s bank account. So why is super any different? It’s yours and you can make it work for you! It is as important to know that you have options with investing your super as it is to know all about the birds and the bees! A little bit of knowledge goes a very long way.

I’m not ready for an SMSF…yet!

That’s okay! You can choose how your money is invested by your superannuation account provider. The first piece of the knowledge puzzle is understanding the lingo! Let’s look at some of the investment options available within industry, retail and corporate funds.

1.    Focussing on growth means investments are mostly in shares and property (approx. 85-100%), this yields higher average returns over the long term. On the flip side, this also means that the losses will be higher in the bad years.

2.    A balanced investment invests less in shares and property (approx. 50-70%) with the rest in fixed interest and cash. The returns are generally reasonable. The growth will be less than in a growth fund but the losses will be lower too.

3.    The conservative approach is the safe bet! The investment is mostly in fixed interest and cash, with less again in shares and property (approx. 30%). It is quite low risk and expects a lower return over the longer term as a result.

4.    Cash means a complete investment of your capital in an Australian deposit-taking institution or in a ‘capital guaranteed’ life insurance policy. This is another version of the conservative approach.

First comes the SMSF, second comes the House!

So you decided to take the plunge and establish your own SMSF – that’s an exciting step towards managing your own wealth. But perhaps an even more exciting step is realising that once you have an SMSF, you may be able to use it to build a property portfolio.

Another investment option (and one of our favourites) is investing in real property using a limited recourse borrowing arrangement or LRBA. What’s that, I hear you say? An LRBA involves your SMSF borrowing money for the purpose of purchasing a single asset (i.e. property) or a collection of the same asset with the same value (i.e. a parcel of one company’s shares). We considered that the sole purpose of establishing a fund matters last month, and it is prudent to consider it again here. The sole purpose of the Fund (and its investments) needs to be to provide benefits to members during retirement. Let’s take real estate - with a bank loan, you are able to purchase residential or commercial property – perhaps the key to the first investment, or a new business premises.

Alternatively, if the loan is from a related party, please keep in mind there are other things to consider. While the LRBA is in place the asset is held by a Holding Trustee in a separate trust. Upon repayment of the loan the asset can be transferred into the name of the Fund Trustee.

The safeguard offered by an LRBA is that if the fund defaults on the loan then the lender is only able to exercise a power of sale over the particular asset in that separate trust, as opposed to over all of the assets of the Fund.

Me + LRBA = what now? (or is an LRBA for me?)

It can be hard to work out if such a large, long-term investment is in your Fund’s best interests, and indeed your own. The absolute first thing you must ask is: Does this fit within the investment strategy of my Fund? And the answer to this question has to be yes for an LRBA to be right for your Fund.

We suggest taking the time to then mull over things such as the following (and please note this is not an exhaustive list):

•    Will your SMSF be able to make the loan repayments?
•    What are the other expenses of your Fund to be accounted for?
•    Are all of the members in it for the long term? What if someone wants to cash out their balance or start a pension – will the asset need to be sold?
•    Who is the lender? Could they call in the loan early, or sell the loan which might vary the terms?
•    What are the associated fees and costs for the loan?
•    If it is real property, will it be leased? Will the Fund manage in times without a tenant?

This is an important decision and one that should not be made until you really understand how the investment would work. So make sure you do your homework and, as we identified last month, speak with your “buddy in the business”!

Playing your cards right, and dealing with the deck you are dealt!

The key message is that there is something for everyone!

Investment is all about knowing what you can do, asking the right questions of the people with the expertise, and being realistic about what you want to achieve. An LRBA, for example, is generally about generating a growth over a long-term investment. Assess the hand you’ve got carefully before you play your next card!

Townsend’s top tip: Get in the know, take control and make ‘super’ superannuation decisions!

If a limited recourse borrowing arrangement sounds like something that you or your young person might be interested in please call Townsends Business & Corporate Lawyers on (02) 8296 6222. Please note that for any advice as to how to develop the investment strategy for your Fund, speak to your financial adviser.