Doing it yourself may be doing it hard

More Australians than ever before are taking control of investing their own super, leading to a rapid rise in the number of self-managed superannuation funds.

According to the Australian Prudential Regulatory Authority(APRA) almost half a million people now manage their own super funds, representing some $70 billion in assets.

Yet the commonly perceived benefits of self-managed super funds, namely greater control over investment strategy and better tax efficiency, can be misleading and many people attracted by these benefits would be better off with a discretionary master trust.

Around 98 per cent of clients who ask Bridges about self-managed funds can get the control and tax efficiency they want more cost effectively from discretionary master trusts. Added to this is the issue that directing investment strategy and administering a super fund is not an easy task.

In fact only highly skilled investors with the ability to equal or outperform professional fund managers should consider self-managed funds. Many of these funds are skewed towards cash and property and deficient in equities, with the latter generally the best performing assets in the long term.

A further issue is that the administration of a self-managed super fund can be complex and time consuming and while younger people may be attracted by the idea of directing their own super investment strategy, they may find it difficult to devote sufficient time to managing the fund. Investors in their 50s or 60s might have the time to do it, but it can become an overwhelming task when people reach their 70s and beyond.

As a result of the complexity and demands on time we are seeing an increasing number of people seeking advice on how to wind down their self-managed fund because they have experienced poor performance and are tired of the administrative burden.

There are some situations where self-managed funds can be very effective, for example, when a business owner wants to purchase business premises via their super fund.

Nonetheless clients should look at a discretionary master trust as an alternative unless they are an experienced investor and confident they can cope with the administrative responsibilities involved in a self-managed fund.

Getting an idea of the actual cost for establishing a DIY fund can be just as difficult and comparing the cost of a DIY fund to other forms of superannuation can be even more difficult to achieve.

Many industry commentators say that if you have $100,000 or more it is more cost effective to start your own self-managed fund, in reality this is true only if the individual invests directly into shares, property and other assets where there is no intermediary.

In looking at the cost of a self-managed fund in comparison to a discretionary master trust there is a need to look at the different layers of services and fees that may be used. These will typically fall into three general types, establishment and administration costs, administration service fees and investment fees.

Detailed below is a simple cost comparison model that aims to provide a picture of the different layers of fees and illustrate how the structure of a DIY fund can vary the cost in comparison to other forms of superannuation.

The fees used below are assumptions based on the average costs of similar products in the market place, many discretionary master trusts and small complying APRA funds provide a sliding scale that reduces the ongoing fee for high net worth clients. We have used 1.6 per cent for this illustration because this is the average ongoing fee for clients worth less than $250,000 for most of the major providers.

In comparing the cost between a self-managed fund, a small complying APRA fund and the discretionary master trust, two case studies will be used where different layers of fees and services are used by the self-managed fund. These will be for an astute investor and an average investor, both with portfolio sizes of $250,000. Cash has also not been included in the master trust fee as this is usually the base investment and does not attract additional fees.

The astute investor would not seek financial advice in the belief that he can manage a direct portfolio himself and outperform most fund managers. In this case he would only require layer one and layer three and he would make cost savings by not using managed funds and any layer two service providers. (see table 1) We have assumed that where the astute investor is using the small complying APRA fund and the discretionary master trust that they have not used a financial planner and have negotiated a nil up-front fee.

Self Managed FundSmall Complying APRA FundDiscretionary Master Trust — Superannuation PlanLayer One fees — DIY CostsLayer One fees — DIY CostsLayer One Fees — Professional Trustee CostsTrust Deed:$600 (one off cost)Trust Deed:$600 (one off cost)Trustee Up-front Fee $220,000 x 0% = $0.00Audits etc: $500Audits etc: $500Trustee on-going Fee $220,000 x 1.6% = $3,520BAS: $200BAS: $200Layer Two Fees —Professional Trustee CostsLayer Two Fees — Wholesale and Direct Investment costsTrustee Up-front Fee $250,000 x 0% = $0.00Cash Management Trust $30,000 x 0.9% = $270*Trustee on-going Fee $250,000 x 1.6% = $4,000Direct Shares 44 trades @ $20 = $880Layer Three Fees — Investment CostsLayer Three Fees — Wholesale & Direct Investment CostsCash Management Trust: $30,000 x 0.9% = $270Cash Management Trust $30,000 x 0.9% = $270Direct Shares 44 trades @ $20 = $880Direct Shares 44 trades @ $20 = $880Total Cost: $2,450Total Fees $6,450Total Cost: $4,670Average %- 0.98 in first year and 0.74 recurring from year 2Average % 2.58% in first year and 2.34 recurring from year 2Average % -1.87 per annum

The average investor would require financial advice and is unlikely to be able to manage a direct investment portfolio that would outperform most fund managers. In this case the client has sought financial advice from a financial planner and has negotiated the planners remuneration to a 2 per cent investment fee and a 0.5 per cent ongoing fee (see table 2). This remuneration needs to be factored into an costing for a self-managed fund, where a discretionary master trust or small complying APRA fund is used the product provider would pay the remuneration as commissions.

In order to access wholesale funds for the self-managed fund the financial planner needs to use the discretionary master trust investment plan or a self-managed superannuation administration service that allows access to wholesale investments.

Self Managed Fund Using Discretionary Master Trust Investment PlanSelf Managed Fund Using Administration ServiceSmall Complying APRA FundDiscretionary Master Trust — Superannuation PlanLayer One fees — DIY CostsLayer One fees — DIY CostsLayer One fees — DIY CostsLayer One Fees — Professional Trustee CostsTrust Deed:$600 (one off cost)Trust Deed:$600 (one off cost)Trust Deed:$600 (one off cost)Trustee Up-front Fee $220,000 x 2% = $4,400Audits etc: $500Audits etc: $500Audits etc: $500Trustee on-going Fee $220,000 x 1.6% = $3,520BAS: $200BAS: $200BAS: $200Layer Two Fees — Non-Super Discretionary Master Trust Layer Two Fees —Administration ServiceLayer Two Fees — Professional TrusteeLayer Two Fees - Wholesale and Direct Investment CostsTrustee Up-front Fee $250,000 x 2% = $5,000Financial Planner Up-front Fee $250,000 x 2% = $5,000Trustee Up-front Fee $250,000 x 2% = $5,000Cash Management Trust $30,000 x 0.9% = $270*Trustee on-going Fee $250,000 x 1.6% = $4,000Financial Planner annual fee 0.5%: $1,250Trustee on-going Fee $250,000 x 1.6% = $4,000Wholesale managed funds $220,000 x 0.9% = $1,980Administration fee $250,000 x 0.5% = $1,250Layer Three Fees -InvestmentsLayer Three Fees -InvestmentsLayer Three Fees Wholesale and Direct Investment CostsCash Management Trust $30,000 x 0.9% = $270Cash Management trust $30,000 x 0.9% = $270Cash management trust $30,000 x 0.9% = $270Wholesale managed Funds $220,000 x 0.9% = $1,980Wholesale managed funds $220,000 x 0.9 = $1,980Wholesale managed funds $220,000 x 0.9% = $1,980Total Cost - $12,550Total Cost - $11,550Total Fees - $12,550Total Cost - $10,170Average %-5.02 in first year and 2.78 recurring from year 2Average % - 4.42 and 2.18 recurring from year 2Average %-5.02 in first year and 2.78 recurring from year 2Average %-4.07 in first year and 2.31 recurring from year 2

The case study shows that a DIY fund can be more cost effective than a master trust dependent upon the structure and amount of services required to manage the DIY fund effectively. The average investor will always need the expertise of the financial adviser and the fund managers in order to achieve a satisfactory return.

While we believe at Bridges that the majority of our clients can be provided with sufficient investment choice and tax effective strategies through a discretionary master trust, this is only true where the discretionary master trust provides the client with an individual tax assessment that allows for many of the typical DIY strategies such as reducing contributions tax etc. We also recognise that DIY funds do provide some strategies for our high net worth clients that cannot be provided for in a discretionary master trust such as managing RBLs with reserving strategies and complying pensions paid from the DIY fund.

These case studies were based on some common DIY fund structures, we also recognise there will be other ways in which DIY funds may be structured.

Ross Johnston is the head of Advisory & Technical Services at Bridges Financial Services