Here, where the world is quiet;
Here, where all trouble seems
Dead winds’ and spent waves’ riot
In doubtful dreams of dreams;
I watch the green field growing

Swinburne, The Garden of Proserpine

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

My portfolio goal is to build up a portfolio capable of providing a passive income of around $87 000 by July 2021 (Portfolio Objective).

Portfolio income summary

• Vanguard Lifestrategy High Growth – $33 314
• Vanguard Lifestrategy Growth – $2 074
• Vanguard Lifestrategy Balanced – $2 621
• Vanguard Diversified Bonds – $1 077
• Vanguard ETF Australian Shares ETF (VAS) – $2 109
• Vanguard ETF International Shares ETF (VGS) – $511
• Betashares Australia 200 ETF (A200) – $2 325
• Telstra shares – $43
• Insurance Australia Group shares – $127
• NIB shares – $120
• Ratesetter (P2P lending) – $724
• Raiz app (Aggressive portfolio) – $83
• Spaceship Voyager app (Index portfolio) – $0
• BrickX (P2P rental real estate) – $35

Total portfolio income in half-year to June 30, 2020: $45 162

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

The following pie chart is a breakdown of the percentage contribution of each investment in the portfolio to the total half-yearly income.

Comments

The total of half-year distributions from the portfolio was $45 162, or the equivalent of around $7 500 per month over the past six months.

This result is the third highest half-year distribution on record, breaking a two year downtrend of lower June figures. These half-year portfolio distributions are substantially larger than June last year, and around double that of June distributions of four years ago.

The level of distributions payout was well above the estimates range set out only a week ago. The forecasts in the last monthly portfolio update ranged from $21 000 to $48 000.

The preferred model estimate – based on past average fund and ETF distributions – underestimated the eventual total distributions by around a quarter. The most accurate estimate for this half-year result actually turned out to be just relying on a simple average of the past three years.

June distributions usually represent around 60 per cent of total annual distributions, just due to the balances and payout schedules of the combination of retail funds and exchange traded funds held.

Ending of the financial year: analysis and implications

The end of the financial year allows comparisons to be made to past years. This financial year total distributions totalled $65 852, or around $5 500 per month.

The chart below gives a history of total portfolio distributions in nominal dollars, with green indicating the period covered by this record.

The over twenty years of data in the chart above shows the strong role that compounding plays as the journey progresses. A small trickle of distributions across that first year of investing – just $327 – has grown into a strong current in later years.

The shape of the distributions reflects the level of the portfolio itself, as well, with slow progress at first, and then substantial gains in the latter periods.

More than half of all distribution income has been received in the last four years (green) of this record. Similarly, more than three-quarters of all distribution income has occurred in the past eight years.

In constant dollar terms, past distributions effectively make up around 30 per cent of the total current value of the portfolio. This highlights that inflation over twenty years can paint a mildly distorted picture of the comparative level of past and present distributions.

The chart below corrects for this distortion by expressing all distributions in real 2019 dollars.

The past four years appears to have established a new operating range for portfolio distributions, with most observations falling within the range of $50 000 to $70 000. This signals a phase shift of sorts from the past levels of distributions evident until 2015-16.

Falls are possible from here. It is notable that on a financial year basis, however, the portfolio has never experienced two consecutive years of falling distributions.

Despite this, it is perfectly feasible that the current coronavirus and associated economic downturn could alter that record, and lead to a sustained period of weaker or flat performance in the years ahead.

Tracking the changing composition of distributions

While a broad picture of distributions growth is evident, under the surface of the portfolio the composition of these distributions is shifting over time.

For more than two years substantive new investments have been made exclusively in exchange traded funds – A200, VAS and, more recently, VGS. This is slowly expanding the significance of their distributions, compared to the Vanguard retail funds that were a larger proportion of the earlier portfolio.

This half-year, however, the Vanguard Diversified High Growth retail fund played a very significant role in overall distributions. This repeats a past observable pattern of this fund playing an important determining part in setting the level of total distributions.

This can be be seen in this chart below, which sets out the level and changes in major components of portfolio distributions through time.

Just discernible on the right of the graph is the growth of distributions from both the VAS (purple) and A200 (blue) exchange traded funds from June 2018 onwards, though these have fallen in this particular half-year period.

Vanguard retail funds have collectively made up more than 85 per cent of total half-year distributions, due to a combination of lower absolute payouts from the exchange traded funds, and most likely, a significant distribution of capital gains from the Vanguard retail funds.

For comparison against the half-year result, the composition of the full 2019-20 financial year distributions is set out in the figure below.

Here the slow shift away from the income dominance of the Vanguard retail funds is more apparent. Around 20 per cent of financial year distributions are from the Australian shares exchange traded funds (VAS and A200).

Rate of change? Establishing the distribution rate of the portfolio

The overall portfolio distribution rate – that is, annual distributions as a raw percentage of the total portfolio value –  for this financial year has been 3.8 per cent.

This measure allows a clearer view of the income performance of the portfolio while accounting for the growing size of the portfolio.

The figure of 3.8 per cent for this financial year just passed is towards the lower end of the rates recorded over time.

Reduced payouts from the exchange traded funds, and declining fixed interest returns and exposures over the life of the portfolio are two factors likely to be driving this outcome.

An illustration of this latter issue is that fixed interest returns – during a period of higher interest rates – made up nearly 40 per cent of all portfolio income over the first half of the journey, compared to around 5 per cent today.

The average distribution rate over the past two decades remains at 4.4 per cent.

Re-fixing the position: tracking progress to ‘credit card FI’ 

The financial year finishing and finalisation of distributions also makes it possible to more accurately review comparative trends in distributions and monthly credit card costs, as well as total expenses.

This chart above has been recalculated to take into account now known distributions over the last twelve months.

It shows that there was a brief window in financial year 2017-18 where unusually high distributions regularly met credit card expenses, and sometimes total estimated expenses.

This unusual result has also been repeated in the last twelve months, with the significant drop off in expenditure during the coronavirus restrictions period clearly visible.

An alternative way of examining the same progress is to consider the extent to which distributions have met estimated total expenses. In this chart below total expenses are defined as actual credit card spending, together with a fixed additional monthly amount allowing for non-card expenses.

Where the blue line of the proportion of total monthly expenditure met by distributions settles over the next year will be interesting to see.

The flat red line in the chart above is set at $87 000, to show progress against my ultimate Portfolio Objective. Once again, the high distributions in 2017 are seen, and the effect of the temporary lockdown on expenditure is evident.

A much less volatile indicator of progress towards distributions income meeting my ‘credit card FI’ goal is the provided in the following chart.

This takes a three-year moving average of both distributions and credit card expenses up to early June – the last available figures.

This graph – which takes into account the updated distributions – shows the expenses and distributions lines now almost touching. The gap between distributions by this measure, and average credit card expenditure is less than $100 per month, and falling.

This closure is a function both of a steady overall reduction – of around 5 per cent – in average credit card expenses over the past three years since July 2017 as well as more recent sharper falls.

Deploying the distributions through the period ahead

The June distributions from the Vanguard funds, and exchange traded funds A200 and VAS, will result in around $41 000 of capital available to be invested or used over the next few weeks.

In accordance with past practice I will put aside a quarter of this to meet future tax liabilities.

My current plan is to reinvest the remaining $30 000 in equal increments on a fortnightly basis though July to December. These increments will be directed according to my asset allocation plan, targeting whichever asset class is furthest from its target allocation in the particular month.

At this stage that is likely to mean further equity investments in the Vanguard Australian shares ETF VAS and its international shares ETF VGS, depending on the relative market movements of Australian and international shares over coming months.

While bond holdings are currently modestly under their target allocation of 15 per cent, the under-allocation issue in equities is more significant (with equities currently being at around 70 per cent, compared to the 75 per cent target).

One longer term issue that this brings is that over coming months I may reach an equal dollar allocation to the Australian shares ETFs VAS and A200. At this point my intent is to seek to keep these two very similar exchange trade funds in rough balance, to maintain equal exposure to both of these products.

Adjusting the emergency fund: reducing the stores

A further regular step following finalising the half-year distributions estimate is to review the level of my emergency fund.

This fund is set at a level of providing the equivalent of one year of expenses equal to my Portfolio Objective target income of $87 000. It has been primarily designed to cover expenses in any unexpected periods without employment income.

The June distributions takes the five-year average of annual distributions to just over $58 000. I have also reviewed alternate estimates based on average per fund or ETF share distributions and long-term estimates of total distributions as a percentage of the portfolio. These two approaches suggest likely forward distributions between $53 000 to $56 000 per year.

An average of all of these approaches suggests likely future distributions of around $56 000 per year. In recognition of this I will be reducing my emergency fund from $33 000 to $31 000.

Over time this trend can be expected to continue. All other things being equal, an increasing average portfolio size will have the impact of lowering my emergency fund as the associated flow of portfolio distributions rises to replace it. I will, however, keep a modest contingency cash allotment for liquidity and unanticipated cash requirements.

Observations

The June distributions are much higher than expected, especially due to the reduced dividends which are to be expected from the impact of coronavirus on company earnings and dividend payout policies.

Some of this is likely due to a component of the higher than expected Vanguard fund payout being distributed capital gains from internal fund rebalancing. This allows deployment of these liberated funds into lower fee, and generally more tax efficient exchange traded funds, with smoother distribution profiles.

Measured over the unusual financial year just past, portfolio distributions actually met and exceeded credit card expenses. Averaged over longer period, the gap between distributions and expenses is gradually reducing, and on a three yearly rolling average basis, has essentially vanished.

Last December I made the analogy of the portfolio notionally representing another additional full-time worker, earning new capital each hour of the day or night on my behalf.

To extend the analogy, this past year this portfolio worker has received the equivalent of a substantial pay rise. Each hour of the work week this additional worker earns around $33.33 an hour towards growing the portfolio.

Or, to put it another way, the portfolio has earned a modest but relentless $7.52 every hour of the day and night for the past year. While nothing has much of a sense of safety at present, the risks associated with future equity and bond earnings are effectively spread across every major economy and industry sector of the world.

The level of June distributions represent a reminder of the limitations of models and expectations in a dynamic market environment. While actions are being taken to smooth the pattern of distributions into the future, it is simply extremely uncertain how future earning and distributions will develop across the next year or two.

In this circumstances, there is a premium on simply controlling what is possible, such as conscious and evidence-based spending and investment decisions.

The winds and waves of this journey seem anything but spent. Yet these most recent results seem to push financial independence beyond being just a dream of a dream, to being a distant shoreline in clearer sight.

Explanatory Notes

1. Income distributions reported do not include franking credits. My current preference is to seek to track cash actually delivered to my bank account as a tangible and easy to calculate measure. In this past financial year franking credits valued at around $8031 were received from all shares, ETFs and Vanguard retail funds.  
2. These figures incorporate minor revisions ($61) to the December 2019 half-year income estimate. These arise from final figures for total interest earned in the Ratesetter account being unavailable until each July, and therefore estimated in the December report.