A key issue for personal investors is that many investment tasks are ‘important but not urgent’, so they are put off indefinitely even though the investor could be far better off over time if action was taken. Changing superannuation fund falls into this category. Millions of Australians have the wrong type of super fund, but they don’t switch. Households with their super in either: retail super funds; low balance SMSFs; or small industry funds can expect a boost of 1 - 2.5% per year on their returns if they switch to one of the large industry funds. The Productivity Commission’s Final Report on superannuation is the latest compelling evidence of how much better large industry funds are for many investors.
Highly effective investors
Stephen Covey’s famous book ‘7 Habits of Highly Effective People’ is 30 years old this year, but it is still a great book for investors to read and think about in the context of their personal investing. In Chapter 3 ‘Putting First Things First’ Covey describes how damaging it is to fall into the habit of working on tasks that are ‘urgent but not important’.
I have illustrated his four categories of tasks in the graphic above. Everyone works on tasks that are both urgent and important. In the context of investing that would include filing taxes and paying bills. But too much time is spent on tasks that are urgent but not important. Reading the financial news is urgent because it is here today, gone tomorrow. Likewise, tweaking your portfolio to sell Amazon and buy Walmart or sell Rio and buy BHP is urgent because your brilliant insight has a short half-life in the market. But those two tasks rank well below other tasks in terms of drivers of the long-term wealth of personal investors.
Spending more time on tasks that are ‘important but not urgent’ makes a huge difference. For investors these tasks would include: understanding spending patterns to save more and spend less; getting asset allocation right (what percentage is allocated to shares, property, fixed income, infrastructure, cash, etc.); and getting structuring and tax planning right. None of these tasks is so urgent that it cannot be put off until tomorrow, next week or next month. Because they are important but not urgent many ineffective investors never undertake these tasks.
I will return below to why these three particular tasks are at the top of the ‘important but not urgent list’ and why changing super fund is in this category. But, first let me explain why I say that millions of Australians have the wrong type of super fund.
The Productivity Commission
The Productivity Commission’s final report on Competition and Efficiency in the Superannuation System, which was released on 10 January, provides a great deal of evidence on what type of super funds deliver higher returns, as follows.
Retail v Large Industry Funds 2.5% higher returns to large industry funds on average
The argument in favour of large, well governed industry super funds, such as: AustralianSuper, Hesta, HostPlus, UniSuper, Rest, SunSuper and others is simple: on average they have much lower fees and much higher returns than retail super funds (which include the funds of AMP, MLC, Colonial First State, etc.). The difference is about 2.5% per year, on average, after fees and taxes.
The lower fees arise from two factors: industry funds don’t have shareholders who need a return on capital, and they don’t spend a lot of money on distribution (marketing and incentives to financial advisors).
The higher returns also have two drivers. The first is industry funds’ higher allocation of investment to illiquid asset classes, such as infrastructure and private equity. By definition illiquid assets cannot be easily liquidated (sold and turned into cash). Investors demand higher returns for holding illiquid assets and so those assets deliver higher returns over time.
Large industry funds can hold a higher proportion of illiquid assets because their members are less inclined (than the members of retail funds) to either withdraw their funds or move it to cash in a financial crisis. Moreover, the constant flow of new money into large industry funds can meet withdrawals in a crisis without the need to sell assets.
The second reason for higher performance is that large industry funds, for the most part, use outside managers and are therefore able to access the full range of quality global asset managers at a comparatively low price.
Low Balance SMSFs v Large Industry Funds 1% higher return to large industry funds on average
About 360,000 of Australia’s 600,000 self managed superannuation funds (SMSFs) have net assets of less than $1 million. Because there are significant fixed costs to running an SMSF the after fee returns of SMSFs are lower for smaller funds. The Productivity Commission reports that SMSFs with net assets of less than $1 million have lower returns, after tax and after fees, than large industry super funds.
There are circumstances where SMSF’s with balances of significantly less than $1 million make sense; including, SMSFs that own the commercial property used in the investor’s business; SMSFs of investors who highly value having complete control of their investments; and SMSFs that are growing quickly towards a higher balance.
But that still leaves 300,000 or more SMSFs that should never have been established. Many of those SMSFs were created on the advice of accountants who were more concerned with the fees to be earned from establishing and then administering SMSFs than the welfare of their clients. In general, the accounting profession has a well-earned reputation for expertise and probity, but the creation of vast numbers of unnecessary SMSFs is a very major blot on that record.
Small Industry Funds v Large Industry Funds 1% higher return to large industry funds on average
Large industry funds (with more than $30 billion of funds under management) have lower fees and earn significantly higher returns for their members, on average, than small industry funds (less than $3 billion) because size matters and the flow of new money matters. Bigger funds can amortise fixed costs over more members. Moreover, they have bigger and better internal investment teams to select external managers and negotiate low fees, as well as managing some money internally.
The flow of money issue is that most small funds are growing very slowly, and some are shrinking. Industry funds with higher flows of new money can hold a higher proportion of illiquid assets, which delivers higher returns over time (as explained above).
Importance of switching funds
Is switching super fund really that important? For an investor who pays 10% of their income into their superannuation over 40 years of employment, a 2.5% per annum improvement in return will yield a superannuation balance at retirement that is about 60% higher, under reasonable assumptions about asset returns, taxes and wage growth.
I am not suggesting that every investor should be considering a large industry fund. Apart from the well-conceived SMSFs mentioned above, there are government and corporate funds that are very beneficial to members. Some State Government super funds are highly advantageous to members in part because of their exemption from Federal Government regulations. Likewise, some large corporate funds have been generously sponsored by corporations.
Ranking importance of tasks
To focus on the most important tasks rather than the most urgent, we need to rank tasks by importance. What are the most important drivers of how much wealth investors will have when their wealth peaks (usually at or close to retirement)? The three most important drivers are:
1. How much is earned and how much is saved (most investors don’t know what proportion of their earnings are saved or how their spending breaks down into big categories);
2. Asset allocation (how much is in Australian shares, global shares, property, fixed income, etc.); and
3. Structuring and tax planning. (Structuring refers to the legal structures that an investor owns their assets in and streams cash flows through; including corporations, family trusts and superannuation funds).
In each case, optimising the drivers of wealth is not a particularly urgent task, but they are the most important things that investors must get right. Many more urgent tasks are less important.
Even small reductions in time spent on ‘urgent but not important’ tasks, to make more time for ‘important but not urgent’ makes a big difference. Changing super funds is a great example of that for so many investors.
My Finance Education for Investors course, which next runs in Melbourne from 30 April, has a structured 10 step approach in which participants examine their current situation and make the necessary changes.
Copyright 2019 Sam Wylie