The process of assessing the optimal mix of assets within a Self Managed Superannuation Fund (“SMSF”) is far more complex than this question alone. The appropriate asset allocation for an individual is dictated by factors such as age, 
tolerance to risk and objectives and will often be a spread of assets across Cash, Fixed Interest, Bonds, Australian Equities, International Equities, Property and alternative assets each having a specific purpose within a consolidated portfolio.
It is no surprise that aside from cash, the two most widely held assets amongst the approx 420,000 SMSF’s registered Australia wide, are Australian Shares and Direct Property. It is a widely debated topic…property vs. shares; however the debate within the Superannuation environment has its own considerations given its low tax structure.
There is not much separating the two as far as long term returns, depending on which time periods you look at, with both shares and residential property returning on average around 11% pa (income and capital growth combined) before costs.
Given some, but not many, Investment Managers or individuals have a better track record at consistently outperforming the “average” for either Shares or Property, … we are going to focus on the other significant considerations, advantages and disadvantages one should take into account when deciding between the two.
Liquidity
An important consideration for members and trustee’s of an SMSF is liquidity. It is important that the fund has sufficient access to assets that can be readily sold and converted to cash to fund expenses and outgoings such as tax, accounting/administration fees, property maintenance, management fees etc.
Direct property is considered an illiquid asset, whereas shares generally have the benefit of being able to be sold, providing access to the proceeds in 4 days time (T+3). There is also the ability to sell part of a shareholding, whereas a property owner does not have the option to sell a bedroom or kitchen of a house.
The issue of liquidity becomes even more important for a retiree who has commenced an Account Based Pension whereby they are required to draw a minimum amount of income from the fund each year based on the account balance.
An example of a potential issue here might be a 61 year old client in pension phase with a $1 million fund balance which is made up of $20,000 in cash and a $980,000 property. If the minimum amount of income to be drawn is $40,000 for the financial year, in the event that the property became untenanted for a period of time the member could potentially find themselves in the position whereby they could not meet the minimum pension payment.
Tax effectiveness
From a tax perspective, there are arguments on both sides.
There are a number of tax deductions available from residential property investments many of them derived from ongoing running expenses and costs. This has the obvious benefit of offsetting taxable income, however given Superannuation income is generally taxed at 15% in accumulation phase and 0% in pension phase the benefits of this deduction are somewhat diminished.
Australian resident companies who pay 30% tax on their profits may impute franking credits to their shareholders on dividends paid from those profits. These franking credits are very valuable in the low tax Superannuation environment. For those who have commenced an Account Based Pension, and receive a fully franked 4% dividend will receive an additional 1.7% tax credit from the ATO at the end of the year.
In addition, depending on the value and location of the property there may be Land Tax to pay which could potentially have a significant effect on the net rental yield of the property.
Volatility
Shares can be considered a highly volatile investment, meaning the value of your investment can move up and down quickly in a short period of time. However, this effect can be smoothed out by portfolio diversification and the length of time you remain invested. Volatility is often caused by uncertainty. We have seen some of the highest recorded levels of uncertainty and volatility in global sharemarkets in the last 2-3 years which would have tested even the most steely of investors.
Property can be considered to have moderate volatility, however it could be argued that this is largely due to the fact that the price of your house is not dictated by supply and demand on a daily basis and this price published daily. If a single property valued at approximately $1mil was put to auction every single weekend, you would be likely to see similar volatility to that seen on a weekly basis through the stock market. You may get $980,000 one weekend, and $1,020,000 the next (a 4% variance) based on the number of bidders that show up on the day, and even things such as emotion and atmosphere on the day. Factors which have a daily impact on share prices.
By virtue of the fact that “average” long-term returns are very similar between shares and property, simple investment theory of risk vs. return would imply the risk of loss of capital from investing in shares vs. property would also be comparable.
Australia has been fortunate that we have been broadly spared the same fate of most developed countries, whereby all asset prices were falling at the same time at a rapid rate, including home values. This is not to say that the Australian property market is immune to sharp corrections in value.
Loan to Value Ratio
The banks will generally lend at a higher loan to value ratio against a property when compared to shares. There is now the ability to leverage your Superannuation fund through use of a bare trust to access gearing to invest in a property within an SMSF. Superannuation legislation has moved to prevent such a strategy being implemented over a portfolio of shares. There are considerable costs involved in setting up such a structure within your SMSF so I suggest accessing professional advice before entering into such an agreement, being sure to look carefully at all the advantages and disadvantages and the overall viability of this strategy.
Ongoing costs
There are a number of transaction costs involved in direct property such as advertising, agent’s fees, insurance, stamp duty, management costs, maintenance and repairs.
The following are some potential costs that may be applicable when investing in shares: brokerage, investment management fees and performance fees.
Income Yield
The income yield from a Superannuation asset becomes increasingly important as one moves into retirement phase within their SMSF. Some of the bank shares are currently yielding dividends close to 7% pa plus franking credits. This may result in almost 10% pa after tax income return in pension phase.
Currently Australian residential property is averaging 4.5% pa in rental income before costs.
The current variance between income yields available through some blue chip shares vs. property either implies that property values may be overheated, or share prices undervalued or a combination of the two.
In summary, shares and residential property markets generally move in different investment cycles…and one would do well to have some exposure to both as a part of a diversified overall retirement asset base. Do your own research thoroughly, and get professional advice where necessary.
James Hunter is a Senior Financial Adviser at Wilson HTM Investment Group. You can contact him on (02) 8247 3105 or james.hunter@wilsonhtm.com.au.
IMPORTANT DISCLAIMER – This article has been prepared by Wilson HTM Ltd (ABN 68 010 529 665), Australian Financial Services Licence No.238375. This information is unsolicited general information only, without regard to any investor’s individual objectives, financial situation or needs. It is not specific advice for any particular investor. Prospective investors should consider the appropriateness of the information in this article, having regard to their own objectives, financial situation and needs. Also changes in legislation may occur quickly, so we recommend that formal advice be sought before acting in any of these areas. The payment, the amount and the level of franking of dividends and the return of capital are not guaranteed. Wilson HTM Ltd does not give, nor do they purport to give, any taxation advice. The application of taxation laws to each investor depends on that investor’s individual circumstances. Accordingly, investors should seek independent professional advice on taxation implications before making any investment decisions.
Related Posts -
Debt is Like Cholesterol If you are like me and in your forties (or older) you will no doubt have had your doctor check your cholesterol. I'd always thought that cholesterol was a bad thing but it seems that is not necessarily the case. You see, cholesterol comes in both good and bad forms. LDL...... -
Margin Lending Margin Lending – what is it all about? One simple wealth strategy to assist you on your journey to financial independence is to establish a margin loan. A margin loan is essentially a loan which enables you to invest borrowed funds in shares or managed funds and therefore potentially achieve......
Related Websites -
Customizing a Budget It is a good idea for you to put together your own unique budget work sheet when it comes to getting started in setting up a budget for your household. Make sure that the categories and the information that you use to plug in your budget information pertains to your...... -
Recovering from Portfolio Losses Many baby boomers suffered severe losses in their portfolio of retirement investments. Now we want to know the best ways for recovering from those losses. These are a few strategies that have come to my attention. Some are conventional and passive. Others will take some work. All are worth considering.......
Twitter
LinkedIn
Digg
Facebook
RSS
Email