The optimal size for SMSFs when it comes to costs

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.

New research should finally lay to rest that old canard that self-managed super funds (SMSFs) with balances of $200,000 or more are not competitive on cost compared with APRA-regulated superannuation funds.

The report by actuarial firm Rice Warner, using information from suppliers of SMSF administration services and validated by data from more than 100,000 SMSFs, showed 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 quite instructive. Even balances of between $100,000 to $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’s 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.

The results of the Rice Warner report, which built on work the actuarial firm did on costs in 2013 for ASIC, would not have surprised SMSF trustees.

Over the past seven years, they have observed the average costs of APRA-regulated super funds rising while SMSF costs have fallen, in large part due to technology.

From personal experience they know it’s cost-effective to open and maintain an SMSF at much lower levels than declared by either the Productivity Commission or ASIC.

Important as the findings of this research are, it needs to be emphasised that costs – and investment returns for that matter – are not the prime reasons that individuals set up an SMSF.

Those two factors are important, but as a survey of 800 SMSF Association members found, individuals’ motivations for leaving the APRA-regulated system to take personal control of their superannuation are far more varied and complex.

Control is key

What the survey highlights is that perennial debate about whether APRA-regulated funds or SMSFs are the best superannuation option based on costs and investment returns is largely irrelevant to the very people to whom it is most important – SMSF trustees.

Instead, it’s the control that an SMSF gives individuals over their retirement income goals that plays an important role in the decision-making process when deciding to establish an SMSF.

In fact, the key reasons why trustees chose an SMSF are control, flexible investment choices, dissatisfaction with their existing fund, and tax and estate planning. Costs and investment returns don’t make the list. In essence, what trustees want is control of their financial futures.

When these qualitative factors are added to the mix of reasons as to why individuals set up SMSFs, it helps explain why trustees are prepared to pay the price of higher administrative costs and lower investment returns when their balances are low.

As the Rice Warner research shows, this is undoubtedly the case, with investment performance directly correlating to fund size.

When the average SMSF balance was between $100,000 and $200,000, their average investment returns lagged their APRA cousins, notching returns of 4.56 per cent and 3.86 per cent in 2017 and 2018, respectively.

But once an SMSF breaks through the $200,000 barrier in funds under management, the difference between the two superannuation sectors starts to quickly narrow.

SMSFs with balances between $200,000 and $500,000 returned 7.07 per cent in 2017 and 6.02 per cent in 2018, not far behind their APRA cousins.

And once a fund exceeded $500,000, average investment returns were comparable with the APRA funds, with SMSFs having balances between $500,000 and $1 million earning returns of 8.64 per cent in 2017 and 7.0 per cent in 2018.

What these numbers say is that once an SMSF reaches $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), their capacity for more extensive and diversified investment portfolios allows 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 survey found, those 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 8,043 funds with balances of less than $200,000 in 2017, 3,208 or 40 per cent had broken through this barrier by 2019, with 24 per cent doing so in the first year.

SMSFs are not for everyone. But for those who do opt for this superannuation vehicle, the Rice Warner research provides reassuring evidence they are not jeopardising their future retirements.

First published in the Australian Financial Review on 4 December 2020.