A New Cost Perspective

Individuals who opt for an SMSF do so for many and varied reasons. Per Amundsen, head of research at Thinktank, analyses why they now have the added comfort of knowing these retirement savings structures are also actually cost-effective.

At 30 June 2015, ATO figures showed there were 533,839 SMSFs. Five years later, at 30 June 2020, that figure stood at 593,375 – a gain of 11.1 per cent. After exponential growth post the global financial crisis (GFC), the rate of increase of those choosing to personally manage their superannuation had fallen back to a more moderate pace.

The slowing growth rate encouraged critics of this super sector to suggest SMSFs were in decline – perhaps even terminal decline. In particular, they pointed to the 2018 and 2019 financial years when the increases were a small 1266 and 4694, respectively, to bolster their case. In 2020, that argument lost some of its validity when the increase in the number of SMSFs was 18,540, illustrating their ongoing attraction. Anecdotal evidence for 2021 suggests another solid gain, highlighting, yet again, an economic crisis does not deter individuals from setting up an SMSF. Quite the contrary.

The simple truth is a significant minority of those with superannuation balances, either in accumulation or retirement phase, want to take personal control of their retirement income strategy. Most appreciate this control comes at a price, that is, they must invest time and effort, especially if they choose not to use specialist advice. But it’s a price they are prepared to pay, even in the face of ongoing criticism that they would be better served by putting their superannuation with Australian Prudential Regulation Authority (APRA)-regulated funds.

No less a body than the Productivity Commission, in its final report into superannuation issued in January 2019, said an SMSF needed a balance of $500,000 to be cost-competitive with APRA-regulated funds. In its draft report, it put that figure at $1 million, but retreated when it became apparent that number could not be justified.

The Australian Securities and Investments Commission (ASIC) also got into the debate with its October 2019 fact sheet, “Self-Managed Super Funds: Are they for you?” To put it bluntly, this document cast SMSFs in a negative light, especially those funds with balances of less than $500,000. But what left the industry both angry and perplexed was ASIC’s assertion that the typical cost of running an SMSF was $13,900 a year, ignoring the fact that using averages ignores the distortions caused by large SMSFs and the use of extensive administration and investment services.

Although the document acknowledged the difficulty of comparing SMSFs with APRAregulated funds, it did just that, overlooking factors such as data consistency problems for investment returns or expense calculations and the retiree demographics of SMSFs (about 50 per cent of SMSFs are in pension phase) and the influence this factor has on asset allocation.

Unsurprisingly, the ASIC fact sheet (it has since been clarified by the regulator) caused much consternation in the SMSF community. So, it was with much relief when the ATO’s 2017/18 statistical overview of SMSFs, released in June 2020, showed the median ‘operating expense’ of SMSFs was $3923 a year. The tax office published more granular expense data, finally considering the significant distortions caused by large SMSFs and funds choosing to use borrowings and buy extensive administrative, insurance and investment services.

What the ATO overview did was issue new tables breaking down median and average expenses by type and fund size, as well as streamlining operating expenses to include auditor fees, management and administration expenses, other amounts and the SMSF supervisory levy. In doing so, it allowed the regulator to conclude an SMSF with a typical establishment balance of between $200,000 and $500,000 would have a median operating expense of about $3400 – a far cry from $13,900.

The final nail in the coffin for those arguing that SMSFs are not competitive on cost compared with APRA-regulated funds came when actuarial firm Rice Warner released a comprehensive research report last November that conclusively showed SMSFs with balances above $200,000 were holding their own on a cost basis.

It is a similar story on investment returns. Various reports have shown those who opt for an SMSF are not greatly disadvantaged compared with APRA-regulated funds, especially when the more conservative asset allocation reflecting a demographic profile much older than the average APRA fund member is considered.

On this issue, the Rice Warner report said: “It’s not possible to provide detailed statistics on the investment performance of individual SMSFs from public data because there is no reporting requirement. The annual ATO statistics do, however, allow an approximate aggregate return to be calculated for the whole sector and compared to the equivalent return for APRA-regulated funds.

“It should be noted that this approach aggregates funds and investment portfolios with different asset allocations and different investment objectives. Individual funds will therefore have performed both better and worse than these averages.

“Nonetheless, the approach provides a useful high-level comparison [and it shows] the SMSF sector has delivered equivalent returns to those of the APRA sector since 2005 in both good years and bad years.”

Something important to recognise is the report’s acknowledgement that: “These results may not support the proposition that SMSFs are better investment managers than APRA funds, but they do indicate that members of SMSFs, in aggregate, are not disadvantaged when compared to APRA funds.

“[As would be expected], the larger SMSFs enjoy higher rates of return than the smaller ones, reflecting their more extensive and diversified investment portfolios.”

As a lender to the sector, Thinktank takes solace from these reports that have a positive story to tell about SMSF costs and investment returns. It is heartening to know this important part of our customer base largely competes on an equal footing. But even if these reports were not as flattering of SMSFs, it’s my strong suspicion many trustees would still opt for this retirement income strategy.

I have long held the view that while costs and investment returns are important, they are certainly not the only reasons why SMSF trustees establish their own funds. Far from it. So, I was intrigued when the SMSF Association released the results of its survey, “Is an SMSF the right answer for you?”, of nearly 800 SMSF trustees during SMSF Week last November that showed the decision to set up a fund was not a simple analysis of costs and returns.

What it revealed, and this was unsurprising, was that an individual’s desire for control over their own personal retirement income goals was a major factor. Other reasons cited included flexible investment choices, dissatisfaction with an existing fund, and tax and estate planning. The survey also gave other insights into a trustee’s SMSF experience including:

• eight out of 10 trustees believe their SMSF is good value for money,

• nine out of 10 trustees believe managing and engaging with their own SMSF provides them with a level of satisfaction,

• around half of all SMSF trustees own or have owned a small business,

• the majority of SMSF trustees spend between one to five hours a month administering their SMSF, and

• over half of the SMSF members surveyed have run their own fund for over 10 years. For me this all helps explain why SMSF critics become so exasperated. From their perspective the evidence, or what they perceive to be the evidence, has them rhetorically asking: “Why take on all this responsibility, often at greater cost and for poorer performance, when an APRAregulated find can do it all for you?” They simply overlook the human factor; that for many it’s a conscious decision to ensure they are in the driver’s seat. Furthermore, they enjoy the drive.

When you consider the background of many SMSF trustees it is hardly surprising. Small business people, farmers, professionals, contractors, people for whom making financial decisions – often difficult ones – is part and parcel of their lives. Why would they think differently when it comes to their superannuation?

These qualitative factors aside, it is reassuring SMSF trustees are not being disadvantaged on cost. Indeed, the Rice Warner research went further than this, saying funds with balances of $200,000 or more are cost-competitive with industry and retail superannuation funds and those with balances of $500,000 or more are typically the cheapest alternative.

The numbers are revealing. Even balances between $100,000 and $150,000 are competitive with APRA-regulated funds, provided a cheaper service provider is used or trustees do some of the administration. For balances of $250,000 or more, SMSFs become the cheapest alternative provided the trustees do some of the administration, or, if seeking full administration, choose one of the cheaper services. It is only when SMSFs fall below $100,000 that they stop being competitive compared with APRA-regulated funds, while funds with less than $50,000 are more expensive than all other alternatives.

There is one final point worth making. The lower an SMSF balance, the worse the investment performance compared with APRA-regulated funds. As the Rice Warner research shows, investment performance directly correlates to SMSF size (see table 1). For the average SMSF with a balance between $100,000 and $200,000, their average investment returns lag their APRAregulated cousins. But once an SMSF breaks through the $200,000 barrier in funds under management, the difference between the two superannuation sectors starts to narrow, a trend that becomes even more noticeable once the $500,000 milestone is achieved. According to Chant West data, the average return of a median APRA-regulated growth fund for the 2017, 2018 and 2019 financial years was 10.8 per cent, 9.4 per cent and 7 per cent respectively.

This is hardly surprising. Once SMSFs hit $500,000, and remember, 63 per cent of SMSFs had balances exceeding $500,000 and only 15 per cent had balances below $200,000 in 2019, they have greater investment flexibility, typically allowing them to enjoy higher returns. By contrast, funds with lower balances are weighted towards cash and term deposits and have less exposure to shares, property and managed funds.

But as the SMSF Association survey found, smaller SMSFs are prepared to play the waiting game, appreciating higher returns will come as their balances grow. And many grow quickly. The Rice Warner research shows that of 8043 funds with balances of less than $200,000 in 2017, 3208 or 40 per cent had broken through this barrier by 2019, with 24 per cent doing so in the first year.

Like any responsible lender, Thinktank would never suggest SMSFs are for everyone. These funds do not suit everyone’s risk profile or simply a willingness to actively engage in their superannuation planning. But for those that do, the rewards, financial and personal, are there. The added comfort factor is they are largely doing so on a level playing field with their APRA-regulated cousins.