Occasionally, we see an SOA that suggests that clients use a SMSF and then invest in a broad portfolio of individual share holdings – up to 40 companies can be recommended. While we like diversification, it can be overdone, and holding shares in that many individual companies is a very inefficient way to achieve it.
Put simply, most investment experts would agree that there is little point in holding a diversified portfolio of individual shares, especially within an entity like a SMSF that has to be audited each year. The reason for this is that, once a substantial number of companies are being held, the overall return of the portfolio is likely to approximate the average for the market on which those shares are traded. Once this happens, the client is typically better off with a low cost managed fund that invests into that same market.
The experts do not agree on what the magical number of companies is, and it would also depend on which companies they were. For example, the four major banks traded on the Australian share market together account for about 30% of the total market capitalisation of that market. These banks all sell the same product, and trade in the same markets themselves. Their investment performance does not vary greatly, especially over the longer-term. Investors holding these four companies would get a similar return from a relatively straight-forward index-based fund trading on the ASX. And remember, most managed funds are index-based.
If the investment vehicle is a self-managed super fund, the managed fund makes for much easier end of year reporting and auditing. The accountant and auditor need only to peruse the information from one fund manager (which is typically designed specifically for ease of use by accountants), rather than needing to sight and account for every dividend receipt, franking credit, etc. The client is also unencumbered by the need for a really big shoe box to hold all their information, and the portfolio does not need to be re-balanced every time new money is contributed or money is withdrawn.
Notwithstanding the above, some clients like to see themselves as Warren Buffett-like figures. They enjoy the task of managing a shareholding. If this is the case, then the adviser can still add value by suggesting that the activity take place within the low-or-no taxed (for older clients) environment of a SMSF. In such cases, the adviser should make explicit that they have not recommended a specific portfolio, but rather that they have suggested that the client use the most advantaged form of investment vehicle. The SOA should make clear that every transaction within the SMSF will increase the compliance cost for that SMSF, perhaps even with an estimate of the marginal cost of every transaction.