ETFs: A Low Cost, Simple and Tax Efficient Investment for SMSFs

• ETF use amongst SMSFs has grown in recent years because investors have realised the immense value proposition of an easy to access, low cost and tax efficient tool to attain equity diversification through a single investment.
• Through the continued use of ETFs as asset allocation, tax management, rebalancing and transition management tools, their usefulness to the SMSF investor should only grow in the years to come.
  

Typically structured like managed funds, but listed and traded on an exchange like stocks, exchange traded funds (ETFs) are flexible trading and investment vehicles that can be used to help the Self-Managed Superannuation Fund (SMSF) investor satisfy a number of critical investment needs.

ETF use amongst SMSFs has grown in recent years because investors have realised the immense value proposition of an easily accessible, low cost and tax efficient tool to attain equity diversification through a single investment.

SMSFs: Lower Fees and Greater Control of your Investment

SMSFs (or do-it-yourself [DIY] superannuation funds) account for 24% of all superannuation assets in Australia, with over $930 billion in assets¹. SMSFs provide members with control over the choice of their investments as defined by their trust deed and investment strategy, the fees being paid and the timing of capital gain realisation.

ETFs can add value to investors through their low management cost, transparent, easy to understand investment strategies and administrative simplicity.

ETFs are Typically Low Cost, Simple, Tax Efficient and an Easy to Access Investment

ETFs are investment funds that trade just like stocks. While they are referenced via a ticker on an exchange, they represent a basket of securities that can target a broad index such as the ASX 200, or target a niche segment such as Australian Resources.

Originally introduced as a tool for institutional investors to invest their cash reserves, ETFs proved to be popular with SMSF investors as well due to their “instant diversification” potential. In addition, the following factors make ETFs a low cost, simple, tax efficient and easily accessible investment for a well-diversified SMSF investor:

• An ETF will usually trade at or close to its net asset value (NAV) and is available to be bought or sold whenever the exchange itself is open for business. As they can for stocks, investors may use limit orders to buy or sell ETF units at desired levels, or stop orders to insure against losses.
• Unlike managed funds, the holdings of most ETFs are fully transparent and available daily. This full disclosure enables investors to make more informed portfolio decisions with greater accuracy.
• ETFs often have lower costs and fees than comparable managed funds due to their lower overhead and staffing costs.
• ETFs are generally more tax efficient than their managed fund counterparts. ETF investors can decide when to sell their ETFs and any associated capital gains taxes are paid at the time of final sale, controlling the timing of tax consequences.

An important Tool for Asset Allocation and Tax Management

ETF use amongst SMSFs has grown in recent years because investors have realised the immense value proposition of an easily accessible, low cost and tax efficient tool to access diversified asset class or niche exposure through a single investment. However, ETFs are also becoming increasingly important instruments that can help the SMSF investor with asset allocation, tax management, rebalancing and transition management.

Asset Allocation

Asset allocation is considered the largest driver for long term investment results. However, asset allocation strategies have historically been difficult for many SMSF investors to implement, given the cost, research efforts and asset size required to achieve a proper level of diversification.

Since their launch in 2001, the SPDR® S&P®/ASX 200 Fund (STW) and SPDR® S&P®/ASX 50 Fund (SFY) have allowed investors to gain broad-based Australian stock market exposure through low cost, easily accessible exchange traded funds.

These particular ETFs can form the indexed equity “core” of a SMSF investment portfolio that has the ability to take on clearly understood equity exposure at a relatively low cost. Additionally, investors can access a range of new market segments and asset classes, including real estate investment trusts (REITs), global equities, emerging markets, currency, fixed income, commodities, and smart beta.

Tax Management

Although ETFs are tax efficient vehicles that could allow investors to time tax consequences of capital gains, they can also be utilised to help SMSFs in accumulation mode minimise their tax bills in other ways.

ETFs ‘pass through’ franking credits from the dividends it receives from constituent companies. For example, investors holding STW on and around the four distribution dates (March, June, September and December) typically receive valuable franking credits along with the dividends to the extent they have been paid by the constituent companies.

Franking credits represent company taxes already paid on corporate profits and can be passed along to shareholders with normal dividends as an “IOU” from the tax office. This credit, in essence, eliminates the double taxation of profits at both the corporate and personal level.

Rebalancing

As investors near retirement they may choose to position their investments more conservatively and opt for a higher yielding equity ETF. The targeted exposure and deep liquidity of some ETFs allow for the simple implementation of periodic portfolio rebalancing. At its most basic level this will involve buying or selling investments, such as ETFs and individual stocks, in relatively small amounts to re-establish the fund’s predetermined asset allocation.

Short Term Cash Management

ETFs can provide a ready, liquid and low cost investment to help bridge the gap between two other investments. If a SMSF redeems from an external manager or some other investment, and plans to roll the proceeds into a new investment that it has not decided on yet, an ETF could be used as a temporary placeholder for those assets.