I must go down to the seas again, to the lonely sea and the sky,
And all I ask is a tall ship and a star to steer her by;
And the wheel’s kick and the wind’s song and the white sail’s shaking,
And a grey mist on the sea’s face, and a grey dawn breaking.

John Masefield, Sea Fever

This is my thirty-first portfolio update. I complete this update monthly to check my progress against my goals.

Portfolio goals

My objectives are to reach a portfolio of:

• $1 598 000 by 31 December 2020. This should produce a real income of about $67 000 (Objective #1) – Achieved
• $1 980 000 by 31 July 2023, to produce a passive income equivalent to $83 000 (Objective #2)

Both of these are based on an expected average real return of 4.19%, or a nominal return of 7.19%, and are expressed in 2018 dollars.

Portfolio summary

• Vanguard Lifestrategy High Growth Fund – $772 490
• Vanguard Lifestrategy Growth Fund  – $44 487
• Vanguard Lifestrategy Balanced Fund – $80 006
• Vanguard Diversified Bonds Fund – $107 352
• Vanguard Australian Shares ETF (VAS) – $88 322
• Betashares Australia 200 ETF (A200) – $260 499
• Telstra shares (TLS) – $2 052
• Insurance Australia Group shares (IAG) – $14 405
• NIB Holdings shares (NHF) – $9 204
• Gold ETF (GOLD.ASX)  – $92 340
• Secured physical gold – $14 807
• Ratesetter (P2P lending) – $22 011
• Bitcoin – $186 350
• Raiz app (Aggressive portfolio) – $15 744
• Spaceship Voyager app (Index portfolio) – $1 991
• BrickX (P2P rental real estate) – $4 643

Total value: $1 716 703 (+$118 079)

Asset allocation

• Australian shares – 40.2% (4.8% under)
• Global shares – 21.5%
• Emerging markets shares – 2.5%
• International small companies – 3.2%
• Total international shares – 27.2% (2.8% under)
• Total shares – 67.4% (7.6% under)
• Total property securities – 0.3% (0.3% over)
• Australian bonds – 5.2%
• International bonds – 10.0%
• Total bonds – 15.2% (0.2% over)
• Gold – 6.2%
• Bitcoin – 10.9%
• Gold and alternatives – 17.1% (7.1% over)

Presented visually, below is a high-level view of the current asset allocation of the portfolio.

Comments

The portfolio has experienced the strongest growth on record through this month, with a total increase of $118 000. This pushes the portfolio well beyond Objective #1 to over $1.7 million.

This has followed a period of unprecedented growth in the absolute value of the portfolio, with an increase of almost $400 000 since January. A remarkable consequence of this is that over 20 per cent of the entire value of the portfolio has come into existence in this short six month period.

This unbroken record instinctively invites expectations of a sharp – and possibly a quite sustained – reversal. I am determined, however, to act in accordance with my asset allocation decisions, not on the basis of overconfidence in my own capacity to predict or time markets.

The key contributors to growth this month have been continued appreciation in the price of Bitcoin, and even more significantly, increases in the value of Australian equities and gold. Lower official cash rates have strongly supported equity value growth, and a sharp increase in the price of gold has occurred. Combined, the gains in equities and gold accounted for over half of the total monthly increase.

New investments this month were focused on Australian equities. Following the lowering of the management fee of the Vanguard ETF VAS  – tracking the ASX300 index – to 0.10 per cent from 1 July, I also made my first new investment in VAS for eighteen months. This lowering leads to the VAS ETF becoming significantly more competitive in fees with the Betashares A200 (which charges 0.07 per cent). It also offers some (small) additional diversification benefit through tracking an additional 100 smaller listed companies.

Accounting for volatility and Bitcoin in asset allocation

The sharp increase Bitcoin’s value over the past month has brought the combination of alternatives (gold and Bitcoin) to just over 17 per cent of my portfolio, higher than sought. Bitcoin continues to serve a role providing portfolio diversification, but its recent increase has actually correlated with a rise in Australian equities. Recent price volatility leaves me conscious that the market value of these holdings could quite easily slip down to $50 000, its position a few short months ago.

If there is a star to steer by in such times, it is provided by the target asset allocation. Tracking back towards that in a time of intense volatility is the task at hand.

To ensure Bitcoin volatility is not unduly driving asset allocation decisions, however, I have started to test any new investment action I am considering taking on a ‘with’ and ‘without’ basis. This involves notionally backing Bitcoin completely out of the portfolio (or, more realistically, adopting a trailing average value) and assessing whether or not the asset allocation ‘signal’ for the direction of future investments changes.

The reason for doing this is to check that I am not undertaking hard to undo portfolio actions monthly merely as a response to Bitcoin’s unique price variations. At one extreme if I remove Bitcoin from allocation considerations (e.g. assume it has no value), I have actually already achieved my target equity allocation of 75 per cent. Taking a less extreme approach, however, of attributing just a lower trailing average value results in a continued signal to make new equity investments.

Waiting for the next set of distributions

This period prior to July distributions being finalised and paid always has a quality of uncertainty and contingency about it. Distributions have been quite volatile over time, principally due to different distribution levels from Vanguard retail funds. In turn, these are likely due to maintaining asset allocations, and irregular distributions of underlying capital gains.

My current July distribution estimates are for around $2600 from the Betashares A200 ETF, $800 from Vanguard’s VAS ETF, and around $16 000 to $23 000 from the Vanguard retail funds. These are based on median and average past distributions over the past 10 years for the funds and the already announced distributions in the case of the ETFs.

This could to mean that in early July I may have around $20 000 of newly available capital to re-invest in the market, however, these estimates are just that. In the past, distributions have at times been both dramatically less and more than anticipated. For example, the Vanguard High Growth fund has twice recently produced July distributions at levels above $30 000.

Following distributions being paid I will be looking to re-invest the capital in accordance with my target allocation. Two factors will likely drive these decisions. First, as discussed above the portfolio remains under its assigned equity allocation. Second, after a year of almost exclusive contributions to Australian equities, the target for that component is almost reached.

This means that a proportion of future contributions will be directed to international equities, to target the 60/40 per cent split I have set based on academic research on the historical record of the optimum balance of reducing volatility while maximising risk adjusted returns.

History of Australian equities research

This month the Reserve Bank of Australia issued a new research paper (pdf) on the history of Australian equities.

This draws on newly collected and analysed historical data on the past century of Australian share market returns, improving on previous incomplete or simplified data sets. Some of the key findings of this report have potential implications for my future portfolio planning. For example, the paper finds:

• Dividend yields since the 1980s have averaged around 4.0 per cent, and prior to that have been 200 basis points lower than previously estimated
• The historical geometric and arithmetic average equity risk premium (the equity return in excess of the 10 year bond rate) is between 4.0 and 5.2 per cent, lower than previous estimates
• Australian and US equity returns are historically very similar
• The overall composition of the Australian share market by sector is remarkably similar to a century ago
• For several years leading up to 2018, the Australian equity market has tracked its historical valuation measures quite closely, with lower than historically average volatility

One implication of this is that in future investment policy reviews, I may need to lower my current estimate of long term real equity returns (currently 5.65 per cent).

Progress

Progress against the objectives, and the additional measures I have reached is set out below.

Summary

The rapid growth in the portfolio has been somewhat disorientating.

On an ‘All Assets’ basis, this has meant that all current expenses could theoretically be met from the portfolio and superannuation assets. Nonetheless, while this is pleasing, my focus remains on reaching my financial independence goals using just the portfolio assets.

The higher markets reach, the more interested I become in learning what I can from other periods of volatility. This has led to absorbing the book Wealth, War and Wisdom, a fascinating study of financial markets and returns through the convulsions of the twentieth century’s world wars and Cold War tensions. It examines the challenge of the protection of real wealth in extreme conditions, finding that a diversified portfolio of real and paper assets, including a large weighting to equities, generally performed well.

The Australian FIRE community has also been sinking its teeth into launches of the ‘Playing with FIRE’ documentary. For those not able to make one of the premieres, AussieFireBug’s most recent podcast provides a really enjoyable post-viewing conversation reflecting on its strengths and weaknesses. Also this month Big ERN has published an interesting guest post on safe withdrawal rates over 60 year periods. It makes the point that the ‘rule’ of 4 per cent can be risky and misleading over long time scales, with withdrawal rates of 3.5 per cent significantly decreasing the failure risk.

The passing of the winter solstice a week ago brings with it the promise of longer and lighter days ahead. The distributions to come also evoke a sense of a possible grey dawn breaking. In just a few days, the mists should lift and navigation of the portfolio towards my financial independence goals should be significantly clearer.