Six clever moves for DIY super

It is an uncertain and worrying time, especially with investors looking to fund their lifestyles in retirement. MICHAEL LAURENCE reveals six strategies for tough markets.

By Michael Laurence

It is an uncertain and worrying time, especially with investors looking to fund their lifestyles in retirement. Here are six strategies for tough markets.

It may seem difficult to believe with the intense turmoil in credit and sharemarkets, but this is a time of opportunity for astute trustees of self-managed super funds.

Consider several of the positives. Australian share prices have fallen by more than 40% from last year’s high, creating some cheap buys for self-managed funds that are willing to buy and hold quality stock for the long-term.

And the low share prices provide a highly tax-efficient opening for you to shift shares from your own name into your DIY super fund. Any capital gains tax (CGT) payable on past capital gains is minimised by the massive price fall. And you may even be eligible for personal tax deductions for the contribution of your shares.

Trustees shouldn’t panic if their funds have exposure to mortgage trusts that have stopped capital redemptions as many investors flee to institutions covered by the Government’s guarantee of deposits in Australian banks, building societies, credit unions, and Australian subsidiaries of foreign-owned banks.

If your super fund is in this position, speak to a financial planner who really understands mortgage trusts and remind yourself that you, in your role as fund trustee, should have always known that mortgage trusts are not highly liquid investments by their very nature. And keep in mind that the regular income distributions from the trusts are not being frozen.

As discussed later in this feature, fund trustees should perhaps now review why they had invested in mortgage trusts in the first place, and consider whether the investments still warrant a place in their portfolios.

Here are six strategies for DIY fund trustees to make the most in these difficult markets.

1. Contribute your shares into your fund

As Alan Freshwater, co-principal of financial planner RetireInvest in Bondi, NSW, explains, depressed share prices mean that the contribution of shares from your own name into your DIY fund will trigger less CGT than otherwise on any past capital growth.

You could save a small fortune in tax, particularly if the shares had been held for a long time. (The transaction of contributing your shares to your super fund will crystallise any past capital gains. From a tax perspective, it is equivalent to selling the shares.)

Peter Fry, director of Fry Financial Services in Victoria and a specialist in self-managed funds, says that depending upon the circumstances, the contribution of your own shares to your super fund could generate a worthwhile capital loss. But he says that capital losses are only useful if they can be offset against personal capital gains, now or in the future.

Of course, the key benefit of transferring your shares into your super fund is to take advantage of super’s concessionally-taxed environment and, eventually, tax-free benefits from age 60. And assets within your superannuation fund that ultimately back a superannuation pension are no longer taxed – representing potentially huge tax-savings in many cases.

Freshwater suggests that you only contribute shares that you want to keep for the long term in your self-managed fund – not the ones that your fund is likely to sell within, say, 12 months.

Consider contributing shares that you believe have been heavily oversold by the market and that should stage a powerful recovery when prices eventually rebound.

Crucially, Freshwater says fund members should keep a close watch on the annual caps on non-concessional and concessional contributions. These caps also apply, of course, to contributions in the form of shares. Under the revamped super system, fund members are limited to:

• Concessional contributions of an indexed $50,000 a year for 2008-09, or $100,000 until 30 June 2012 if over 50. (For employees, “concessional contributions” are salary-sacrificed contributions and superannuation guarantee contributions. And for the self-employed and certain other members outside the workforce, concessional contributions are personally deductible.)
• Non-concessional contributions of $150,000 a year for 2008-09 or a total of $450,000 over three years. (Non-concessional contributions are not deductible.)

2. Claim tax deductions for share contributions if eligible

Self-employed taxpayers – meaning owners of unincorporated businesses – and other eligible individuals outside the workforce can potentially wipeout or much reduce CGT triggered by the transfer of shares into their DIY funds (see the above strategy).

This can potentially be achieved by contributing the shares to their fund as concessional or deductible contributions.

Generally, you would be eligible to claim deductions for your personal contributions within the annual cap (again, see above) if you earn less than 10% of your income as an employee.

Bear in mind that shares are often jointly owned by married couples, enabling each spouse to contribute them to the same DIY super fund – doubling the potential deductions within the annual cap on concessional contributions.

Freshwater of RetireInvest describes gaining deductions for all contributions of shares into a DIY fund if possible as “the ultimate outcome”.

3. Check your fund’s cash management trust

Given the Government’s guarantee on deposits in “authorised deposit-taking institutions” (in other words, mainly banks), fund trustees should ensure that they are satisfied with the position of any cash management trust (CMT) in which their funds hold cash. Many self-managed funds use a CMT to receive contributions and to hold the proceeds from asset sales until reinvestment.

CMTs are not covered by the Government’s deposit guarantee. However, the Macquarie Group, for instance, has issued a statement saying that its CMT, Australia’s biggest, is now invested solely in bank-issued securities and deposits that are covered by the Government guarantee.

Peter Fry says CMTs that restrict their underlying investments to those covered by the Government’s deposit guarantee are gaining that guarantee by default, and investors are reliant on the fund managers “doing the right thing”.

Fry suggests that fund trustees speak to their financial planners if they need reassurance regarding CMTs used by their funds.

4. Review investments in mortgage trusts

In the wake of the freezing of redemptions by some large mortgage trust managers, trustees should calmly examine their funds’ positions if holding units in this type of fund. Significantly, no mortgage trust manager is freezing the regular income distributions of their funds.

Fry says units in a mortgage trust should not be looked upon as being the equivalent of cash deposits. And he urges trustees to speak to their advisers if they have any concerns.

Robert Lipman, chief executive of Investec Private Client Advisers, says none of his clients have exposure to mortgage trusts. “I have always had reservations about them as appropriate investments for clients,” he says.

“My reservations are because of the illiquidity of their assets; the transparency of the product is not that good – investors do not have a good idea of the number of mortgages in default or in arrears at the time of investing – and they are higher-risk investments.” Lipman says borrowers who typically cannot get finance from banks borrow from mortgage trusts.

“I am not saying that mortgage trusts do not have a role in an investment portfolio. But investors should have a very good handle on the risks and understand the state of the underlying mortgages, the risks involved, and that they are higher-risk, illiquid investments.”

Lipman emphasises that not all mortgage trusts are identical, with some having better management and better reporting standards. “If choosing a mortgage trust, do your research well and be extra-vigilant in making the investment decision.”

He says existing investors in the trusts should not panic. “There were lots of redemptions taking place following the guarantee to deposit-taking institutions, but that doesn’t mean the [mortgage] trusts will be unable to cope given time.”

Any advice about mortgage trusts, says Lipman, should be given by advisers who really understand these investments.

Alan Dixon, managing director of Dixon Advisory, a specialist adviser and administrator of self-managed funds, says his group has not regarded mortgage trusts as attractive investments for the past five years. Dixon says the trusts had already been hit by the turbulence in the financial markets and are now having to deal with not being covered by the Government’s guarantee on deposit-taking institutions.

5. Take advantage of depressed share prices

A logical approach to buying quality shares that have been dumped by panicking investors is to begin by reviewing how the downturn in share prices has moved your fund’s portfolio away from its long-term or strategic asset allocation. (This is the intended allocation of your fund’s portfolio for the long term between the main investment sectors such as shares, property, bonds and cash to reflect such key factors as the fund members’ personal needs, including their tolerance to risk.)

Your fund’s trustees, for instance, may have decided that the appropriate long-term or strategic asset allocation for your fund in shares is, say, 60% of the value of its assets. But the sharp fall in share prices may mean that shares now comprise a much smaller percentage.

Your trustees may make a decision to carefully move your fund’s portfolio back closer to its strategic long-term asset allocation by progressively increasingly its exposure to shares.

Fry says that investors, including DIY funds, could consider a dollar-cost-averaging strategy to now invest into more shares if appropriate. Dollar-cost-averaging involves investing an amount of capital into the market at regular intervals to reduce, at this time, the risks of being caught by a sudden downturn in prices.

Fund trustees would have to be particularly game to invest a huge amount of their fund’s cash all at one time into this highly volatile market. The dollar-cost-averaging approach appears to make much sense.

6. Don’t jump out of shares into direct residential property

As examined in SmartCompany last week, the outlook for the residential property market is extremely uncertain.

Fry describes residential property as a large investment with poor liquidity and very low yields. A costly piece of real estate can dominate a fund’s portfolio, inhibiting the ability to diversify for risk and return in at least the main investment sectors.

And shares would typically be sold at low, low prices to finance a property. As Alan Freshwater says, “it would be a very big call” to move from shares to direct property, and upsetting your fund’s long-term or strategic asset allocation.

Related articles:

>> 7 tactics to bullet-proof your DIY super

>> 5 smart steps for DIY super trustees