HomeFinanceSuperannuationHow to build an SMSF using ETFs

How to build an SMSF using ETFs

Whether at the accumulation stage or the retirement stage, most experts recommend that an SMSF should be invested in a range of assets, including equities, bonds, hybrids and cash.

Spreading your funds across these asset classes enables you to construct a portfolio that gives you the potential for growth and a level of income that is appropriate for your life stage and financial goals.

Constructing a diversified portfolio may sound like a daunting task, but with the range of ETFs now available on the ASX, it’s possible to build a diversified SMSF using just a few ETFs.

The full risk-reward spectrum: from shares to cash

Cash and Australian equities are examples of two asset classes with very different risk and return characteristics.

At one end of the risk/return spectrum, equities can be volatile – but also tend to offer relatively high returns compared to keeping your cash in the bank. In the 10 years to 31 December 2021, for example, Australian shares1 generated a return of 10.8 per cent per annum. In three of those years, returns were greater than 20 per cent, though in one year returns were negative.

Investors can gain exposure to the top 200 companies on the Australian share market in a single ASX trade, via the BetaShares Australia 200 ETF (A200), at a management fee of just 0.07 per cent per annum.2

At the other end of the spectrum, over the same period, the compound annual returns from cash (as conventionally measured among fund managers by an index of short-term bank debt securities called ‘bank bills’) were only 1.9 per cent, though with no negative return year. Cash returns in more recent years have been even lower, due to the decline in interest rates to historic lows – although recent months have seen returns move higher as the RBA raised the cash rate.

Read: Growth vs income investments: you can have your cake and eat it too

If you want to invest some of your money in cash, that’s also possible through an ETF, such as the BetaShares Australian High Interest Cash ETF (AAA) – and often with attractive yields compared to locking your money in more inflexible term deposits.

Diversification doesn’t end there. Other asset classes, all of which can be invested conveniently and cost-effectively via ETFs, include:

International equities tend to be as volatile as Australian equities, but the beauty of blending them with Australian equities is that it can lower overall return volatility, as the returns of the two are not perfectly correlated. A key reason for this is that the Australian market is top-heavy in banking and resource stocks, while global markets – especially the US – typically have a higher weighting in technology stocks.

Australian investors could consider combining an Australian equities exposure, such as A200, with one or more ETFs offering international exposure.

For example, the BetaShares NASDAQ 100 ETF (NDQ) offers exposure to 100 of the largest non-financial companies listed on the NASDAQ market, including many of the world’s most innovative companies, such as Apple, Amazon and Google.

The BetaShares Global Quality Leaders ETF (QLTY) provides access to a diversified portfolio of 150 of the world’s highest quality companies in a single ASX trade.

You can also consider ETFs that provide a more focused exposure, such as to a particular region (e.g. the BetaShares FTSE 100 ETF (F100)), a particular sector (BetaShares Global Banks ETF – Currency Hedged (BNKS)) or a particular investment theme (BetaShares Global Cybersecurity ETF (HACK) or the BetaShares Climate Change Innovation ETF (ERTH)).

Spreading your equities allocation across several ETFs reduces your exposure to any one sector or market doing especially poorly at any given time.

Looking beyond equities

Arguably one of the best ways to diversify a share portfolio is to add fixed-rate bonds. Australian bonds3 produced returns of 4.2 per cent per annum over the decade to 31 December 2021, with one negative return year.

Although it’s not always the case, equities and bonds typically have enjoyed negatively correlated returns – especially in major risk-off periods such as 2020’s COVID crash and the global financial crisis of 2008-09.

Bonds have tended to offer lower returns over time than equities, but their volatility has also been lower. And the beauty of the negative return correlation with equities is that blending exposure to both asset classes has the potential to improve ‘risk-adjusted’ portfolio returns, helping to lower portfolio volatility significantly without giving up much return.

ETFs are available on the ASX that offer exposure to both corporate and government bonds, both Australian and international.

Read: Retirement investing – What you need to know

Finding a middle ground – hybrids

Another asset class accessible through ETFs is hybrid securities (or ‘hybrids’), which have risk and return features somewhere between that of traditional fixed rate bonds and equities.

Hybrids can offer attractive income returns – including franking credits – typically above that of cash and fixed-rate bonds, and with return volatility somewhere between that of bonds and equities. BetaShares offers two funds that provide exposure to hybrids:

What does a diversified portfolio look like?

The exact blend of asset classes that’s right for an SMSF depends largely on your life stage, and whether you are in the accumulation or retirement phase.

For investors with many years until retirement, the focus is typically on growth. The bulk of the SMSF will most likely be allocated to growth assets, in particular equities, both international and Australian.

As you approach retirement, most experts recommend decreasing your allocation to growth assets and increasing your allocation to defensive assets such as bonds and cash.

SMSFs in the retirement phase are typically focused on income, meaning the bulk of the portfolio will most likely be allocated to fixed income investments, hybrids and equities that pay meaningful dividends. However, to mitigate the effect of inflation and to ensure that you don’t outlive your nest egg, an allocation to growth assets is still generally regarded as important.

One frequently mentioned guideline is the ‘age in bonds’ rule. According to this rule, if you’re 30, that would suggest an asset allocation of ~30 per cent to fixed income and ~70 per cent to equities. The older you are, the higher your allocation to bonds, lowering the overall portfolio risk. At age 70, this rule would suggest an allocation of ~70 per cent to fixed income and ~30 per cent to equities.

Of course, you don’t need to apply this rule hard and fast. For example, you might elect to blend in some hybrid exposure in place of some of your bond and/or equity allocation. And more adventurous investors might even add commodity exposure, such as an ETF that invests in gold bullion.

Read: Long-term investing: Navigating market volatility

Portfolio maintenance

To ensure your asset allocation remains in the range you prefer, it’s important to review and rebalance your portfolio over time. For example, if equities have had an especially strong year, they may now represent a higher proportion of your portfolio than you would like. You might consider reducing your exposure to equities back to a level you are comfortable with.

If your equities exposure is in the form of a few ETFs, this adjustment is easy to make, requiring only a small number of transactions. Compare this with a direct holding of multiple individual shares, which could require many transactions if each holding is to be reduced proportionally.

BetaShares is a YourLifeChoices preferred partner.

1. As measured by the S&P/ASX 200 Index. Past performance is not indicative of future performance of any index or ETF. Index performance does not take into account ETF fees and costs. You cannot invest directly in an index.
2. Other costs, such as transaction costs, may apply. Refer to the Product Disclosure Statement for more information.
3. Australian bonds represented by the Bloomberg AusBond Composite Bond Index. Past performance is not indicative of future performance.

This article has been prepared by BetaShares Capital Ltd (ABN 78 139 566 868 AFSL 341181) and contains general information only. It does not constitute personal financial advice and should not be relied upon as such. It does not take into account any investors’ individual circumstances, financial objectives or needs and does not purport to provide comprehensive information about any matter.
Copyright © BetaShares 2022. All Rights Reserved.

Have you considered using ETFs to fund your retirement? Do you have any experience investing in ETFs? Or do you have a question you’d like to ask about ETFs? Why not share your thoughts in the comments section below?

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