Set your course by the stars, not by the lights of every passing ship.

Omar Bradley

Twice a year I prepare a summary of the total income from my portfolio. This is my sixth passive income update since starting this blog. As part of the transparency and accountability of this journey, I regularly report this income.

My goals are to build up a portfolio providing for a passive income of around $67 000 by 31 December 2020 (Objective #1) and $83 000 by July 2023 (Objective #2).

Passive income summary

• Vanguard Lifestrategy High Growth – $25 606
• Vanguard Lifestrategy Growth – $1 626
• Vanguard Lifestrategy Balanced – $1 630
• Vanguard Diversified Bonds – $53
• Vanguard ETF Australian Shares ETF (VAS) – $1 761
• Betashares Australia 200 ETF (A200) – $4 513
• Telstra shares – $43
• Insurance Australia Group shares – $209
• NIB shares – $120
• Ratesetter (P2P lending) – $1 373
• Raiz app (Aggressive portfolio) – $107
• Spaceship Voyager app (Index portfolio) – $0
• BrickX (P2P rental real estate) – $36

Total passive income in half year to June 30, 2019: $37 077

The chart below sets out the passive income received on a half-yearly basis from the portfolio over the past three years.

The following figure is a breakdown of the percentage contribution of each investment type to the total half year income.

Comments

The total half year passive income from the portfolio was $37 077, the equivalent of $6 180 per month, and above my recent expectations. This was a significant rise from the previous half year to the end of December, consistent with the usual pattern of June distributions being higher.

This June half year result is, however, significantly lower than the equivalent 2017 and 2018 figures. It is now apparent that these previous two results were outliers, as they included significant payments arising from realisations of capital gains and the re-balancing activities of the Vanguard diversified retail funds.

Stepping back and examining distributions over the full financial year presents another longer-term perspective. Full year distributions have recovered from the poor start in the half to December 2018, and the full financial year results are $52 524, or just under $4 400 per month. This is fairly close to my recent estimates of the likely income potential of the portfolio at current levels.

In the chart below of the history of total portfolio distributions, green indicates periods covered by this record.

From this chart it is apparent that annual distributions have fallen significantly – around 20 to 30 per cent – compared to the past two financial years. Yet it is also clear that they have moved structurally above the years previous to this due to the continued growth in the size of the portfolio.

A year-on-year fall in annual distributions such as experienced this financial year is relatively rare – having not occurred since 2012 – but not unprecedented in the history of the portfolio. It has occurred on three other occasions over the past two decades. To date, a consecutive yearly decline has never happened.

Journey to credit card FI – a steadily closing gap? 

The full financial year data also makes it possible to recalculate comparative trends in distributions and monthly credit card costs as well as other expenses on a more representative basis than the previous unusually low December half-year income.

This chart below shows that from April 2019 and for the first time in about a year, credit card expenses have dipped temporarily below annual distributions.

This may not be sustained over time, as this series is naturally quite volatile. As expected, there is still a gap between estimated total expenses and distributions.

To provide a clearer picture of progress towards passive income meeting my ‘credit card FI’ goal, the following chart takes a three-year moving average of both distributions and credit card expenses.

This shows the gap continuing to close, to a remaining gap of less than $1 000 per month between credit card expenses and average distributions.

Changing composition of distributions and sources of variations

Over time the level of distributions will be affected by ongoing changes in portfolio composition.

The fall in the Ratesetter account balance and fixed income holdings overall will tend to reduce future distributions. Similarly, the large and growing investments in ETFs such as VAS and A200 will, at least in a relative sense, reduce the overall portfolio impact of the more volatile Vanguard fund distributions.

The reason for this can be seen in this new chart below, which tracks the major components of distributions through time.

This highlights the dominating influence of variations in the distribution payouts from the Vanguard High Growth Fund through time on overall distributions. It also shows that up until five years ago Ratesetter interest income represented one of the single largest components of distributions compared to just four per cent now.

The half year composition of distributions already given also reflects their cyclical payout pattern, with around 70 per cent being from the single largest Vanguard High Growth fund. Over time, the lower than average distributions from the Betashares A200 ETF – reflecting its market entry and rapid growth – should normalise, possibly representing a slight upward factor in its role in future distributions.

For a point of comparison against the half year result, the composition of the full financial year distributions is set out in the figure below. 

From this it is apparent that collectively the distributions from the Vanguard High Growth fund, the A200 ETF and Vanguard’s VAS ETF decisively shape overall distributions currently, making up nearly 85 per cent of total payments.

The overall portfolio distribution rate (e.g. distributions as a percentage of the portfolio value) for this half year has been 3.5 per cent, one of the lowest rates recorded so far. This is likely due to falling fixed interest returns and the increased use of ETFs with lower payouts of capital gains than the Vanguard retail funds. The average (median) distribution rate over the past two decades remains steady at 4.4 per cent.

Making course adjustments – putting distributions to work

The imminent payment of the July distributions from Vanguard funds, as well as the distributions from the Betashares A200 and VAS means that a total of around $30 000 will need to be reinvested or allocated in weeks ahead.

I will set aside around 25 per cent of this sum to meet the associated tax liabilities, and then expect to reinvest the remainder in even increments on a regular basis over the next six months. While market performance and history suggests a single lump sum investment would be financially optimal, my general practice is to use dollar cost averaging for large sums, to manage the risk of investing prior to a large market movement, and recognise the potential power of ‘decision regret’.

My current intention is to reinvest these distributions in Vanguard’s global shares ETF (VGS). This will be my first investment in this ETF, and flows from the fact that ‘the big rebalance’ to reach my intended 60/40 allocation split between Australian and international equities is now effectively complete.

Historically, I have been wary of this ETF’s high US equity market exposure, and its past returns have been strong (indicating the potential for a reversion to lower returns). However, I am seeking to follow my planned asset allocation, and have some expectation that any external events likely to reduce US and global returns will also likely impact on the Australian dollar, potentially partially offsetting some negative impacts. I am also attracted to the broad simple diversification it offers into areas not well covered by Australian equities.

A further step following from finalising the half year income estimate is to revise the level of my emergency fund. This is set at providing the equivalent of one year of expenses at a level equal to my Objective #2 target income – that is, $83 000. It has been primarily designed to cover expenses in any unexpected periods without employment income.

This most recent set of distributions takes the five-year average of distributions to just over $50 000. On that basis, I am reducing my emergency fund to $33 000, and using the additional capital this frees up as new contributions to the portfolio. Over time the growing average portfolio size should have the impact of tending to lower my emergency fund as the associated flow of distributions rises to replace it. Despite this, I always intend to keep a modest contingency cash allotment for liquidity and unanticipated cash requirements.

Observations

Around 251 years ago, Captain James Cook set sail for a journey across the entire Pacific Ocean to reach the island of Tahiti. His instructions were to witness and record the transit of Venus – that is, the journey of that planet against the disc of the Sun. Scientists and astronomers at that time hoped that by taking a range of measurements as the transit occurred, they might divine the distance between the Earth and Sun.

Similarly, this set of observations helps me understand some of the key measurements in my narrower universe – for example, my distance to a lifestyle funded by passive income, and the broad boundaries around the variability in that income that I might expect.

For much of the past six months, my curiosity about this particular result has been growing. While as a half year it is less spectacular than some past results, it feels like a firm foundation of what the portfolio might be expected to deliver on average over time. It also reasonably matches my previous analysis of the portfolio income potential.

On an annual basis, $52 000 of income represents a more than adequate level of basic financial security in my circumstances. The new figures also provide a cross-check on other measures of progress I use, reinforcing that I am now in a phase of consistently seeking to close the remaining gap between expenses and average total portfolio returns.

As global and domestic markets appear more ominous and finely poised, the relative stability of this income source compared to absolute capital values will also play a psychological role in allowing continued strong investments in equities ahead. Whether this be into storms or calms seas will soon enough be seen.

Explanatory Notes

1. Income distributions reported do not include franking credits. My current preference is to seek to track cash actually delivered into my bank account as a tangible and easy to calculate measure. In this past half year franking credits valued at just under $2200 were received from shares and ETFs (not including the Vanguard retail funds). 
2. There has been a small downward revision to the half year to December 31, 2018 income estimate of $15 602 to $15 447. This reflects the availability of better data from the annual tax statement, and substituting that data for projections made in December 2018.