By Darren Withers

Recent self managed super fund (SMSF) data has indicated that many funds continue to be very focussed in just one or two asset classes.  This is such a significant risk for those investors that in years past the ATO has even taken the step of writing to them suggesting their investments might breach super fund rules.  It is actually a requirement for SMSF trustees to consider the need for diversification and adequately manage risk.  Failure to do this could even see SMSF trustee’s issues with administrative penalties of $5,500.

So, why is the ATO so worried about this? And is diversification really that important?

The Super Industry Supervision (SIS) Act regulations require super fund trustees to give consideration to an appropriate investment strategy and clearly document the reasons behind their investment decisions. Included, is the requirement to consider the investments as a whole, including “the extent to which they are diverse or expose the fund to risks from inadequate diversification”.

So, the regulators clearly think that diversity is important. So much so, that it has been put into law that super fund investors need to consider it. While there can still be good reasons why a less diversified strategy might be appropriate, it usually makes good sense to spread your risk.

The main reason for investing across different assets is to reduce the chance of a bad event from impacting your entire portfolio. Conversely, by having a broader exposure, you are more likely to have exposure to growth opportunities that you may otherwise miss out on.

This applies to both the different asset classes, as well as assets within a particular asset class. For example, if you only had Australian shares, your returns would suffer if the Australian economy lagged the rest of the world. And, even though a particular share you own might be performing well, if you have too much invested in it, you could be caught out if its fortunes change.

Even cash has its role. While the current environment means the return is basically zero, there weren’t too many people complaining about too much cash when COVID hit the equity markets in March and April.

So, by spreading your investments across different asset classes, it is possible to reduce volatility, minimise risk of loss, get exposure to more opportunities and limit the impact of adverse market cycles.

At Elston we believe in diversification and constructing portfolios according to an individual’s goals. While everyone wants to make as much as possible, each person also has liquidity requirements and limits as to the amount of risk they can withstand.

As the ATO is right to point out, rarely is the optimal strategy to invest into just one asset class.

If you would like more information please call 1300 ELSTON or contact us to speak to one of our advisers.