How to protect your investments from a sharemarket correction

Share markets will always go up and down and investors can often benefit from this volatility.  But volatility brings with it risks that are important to understand and, as much as possible, control.

We present a five-step process to help ensure your funds can withstand serious market falls – and also profit from market rises.

Step one: consider your lifestage

Your lifestage refers to whether you are, for instance, retired or still working. Or it may take into account the fact you may not be working at the moment to care for family members, but will return to work down the track.

Your asset allocation should reflect your lifestage. For instance, if you are under age 65 and retired, there’s a requirement to pay out 4% of the fund’s assets as a pension annually. Someone in this stage must ensure the assets in the fund can support this income.

When a member reaches 80, however, the pension payout must be 7% of the fund.

There’s a very big difference between a payout of 4% and a payout of 7%. Trustees that don’t keep this in mind may find they experience problems down the track.

Step two: factor in your age

Often, an SMSF’s members will be of very different ages – for instance one member may be 45 and still working, whereas another may be 60 and retired.

Because of their different ages, each member will need to think differently about asset allocation and the way volatility may impact their assets. It’s common to have different assets for different members.

Step three: think about the fund’s size

The right asset allocation for the fund will often depend on its size.

Think about an SMSF with $10 million in assets. When the fund is that large, it could in fact be over exposed to growth assets like commercial property and shares, because the income from the fund is likely to meet the members’ lifestyle needs. As a result, they are unlikely to need to use the capital in the fund or be so concerned about liquidity.

In contrast, the right asset allocation is critical for a $1 million fund that needs to pay members $80,000 a year in income as these members will be drawing on capital to fund a pension of this size. Therefore a $1million fund will be very different to a $10 million fund in terms of asset allocation and liquidity needs.

It’s likely members of the smaller fund will need to use the underlying capital, and some exposure to growth assets may be required to ensure the fund can meet members’ income needs in retirement.

Trustees of smaller funds need to plan in advance to ensure they are not forced to sell property when there is a downturn in the property market, or shares when the share market falls, to generate the income they need to live.

Step four: liquidity matters

Clients are often disciplined about planning for their regular income payments, but also need to think about planning for one-off expenses to help protect the fund from a correction.

It’s useful to think about your cash requirements two years in advance to ensure it’s available at the right time.

If you want to spend $25,000 on a holiday, for instance, it’s an idea to plan ahead so you don’t have to sell assets to get access to these funds when the market is trending down.

Step five: be diversified

Another way to protect your SMSF from a serious share market downturn is to invest in a wide variety of asset classes and undertake research into asset classes that are outside the major ones of cash, fixed interest, property and shares.

An exposure to infrastructure, for instance, is a great way to diversify the fund and help protect it from a share market correction. The value of direct infrastructure assets tend to be uncorrelated with share markets, which helps to stabilise portfolio returns when markets are bumpy.

The underlying revenue streams from infrastructure often come from monopoly assets such as ports or airports, and may be underwritten by long-term government contracts.

Finally, it’s important to ensure the fund is well balanced.

Don’t bet the farm or put too much money into a small number of asset classes. Take the time to do your research, think through your future income needs and structure your SMSF accordingly.

Centra Wealth Group
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Zac Zacharia (Managing Director) has been assisting clients to create wealth and secure their futures for over 14 years.

He is also an accomplished presenter and educator

Co-authoring the popular investment book, Property vs Shares.