Why choose a SMSF as a saving option

Investing is regarded as complex and confusing right? That’s why you need a financial adviser to help you, isn’t it?

Man Shadow illustrating that costs cast a long shadow

That is true, but the costs of using a financial adviser or even a regular superannuation fund can often erode the investment returns and these costs are often hidden.

Self-managed superannuation fund

While it is probably better to be self-reliant, applying yourself properly to identifying and evaluating investments, takes time and is highly unlikely to result in above average results over the long run.

It’s also risky to not evaluate investments appropriately and act outside your circle of competence.

In Australia however, we have a unique situation that allows hundreds of thousand of small superannuation funds to be managed by their beneficiaries who act as trustees.

In Common Sense on Mutual Funds, John C. Bogle highlights that:

  • although we hear of the benefits of compounding returns we are seldom told about compounding costs or factor this into our long-term plans,
  • very few fund managers achieve market beating returns, especially over the long run, yet they are rewarded with a significant proportion of investment returns,
  • costs do matter and simplicity is the best way to avoid costs

I have realised that for those with the time, skills and discipline there is the opportunity to have more self direction and control over their retirement funds.  On the other hand, those that rely on outside help, will have to pay advisers which will bring them little benefit and cost them dearly in terms of returns on their investment.

The message is clear.  By setting up a SMSF you have the opportunity to eliminate costs by:

  • maintaining a simply structured SMSF, without ongoing professional advice.
  • investing while staying within your circle of competence, achieving appropriate diversification, maintaining high liquidity and staying focused for the long term.

What is an annuity?

An annuity is a financial product paying an income stream to the buyer for a period of time.  The income stream is paid monthly (or quarterly, semi-annually , or annually).

The person receiving the income is usually the buyer or, spouse or, children of the buyer. An annuity contract usually includes a  purchaser, an issuer of the contract, usually an insurance company. When purchased with a superannuation lump sum the recipient of the regular income is restricted to the buyer or spouse.

Purpose of annuity

These contracts are usually intended to pay an income for the life of the person or lives of two persons .  The term of the the income stream may however be fixed, such as 10 years.  When an annuity is arranged for the lifetime of a person the arrangement is referred to as a lifetime annuity.  The term for which the regular payments will therefore be paid for is the uncertain lifetime of the annuitant (the person entitled to the income).  This is the key benefit of an annuity.

Benefits of annuity

The benefit is that the person receiving the income stream will receive a fixed payment over a period of time.  They know exactly how much they will receive and when.  If taken for life then the annuitant cannot outlive the income stream.  If an annuity is taken out to last the lifetime of the persons receiving the income stream and they live longer than expected it will be to their advantage. This is the unique benefit of an annuity—it eliminates the risk of personal longevity.

Risks of an annuity

As the income stream is fixed, with inflation, it will not maintain its purchasing power.  If the person receiving the regular income dies soon after entering into the annuity contract, some of their money will have have been forfeited to the issuer. So there is no protection of income against inflation and there is no preservation of capital.