Day by day, what you choose, what you think and what you do is who you become.

Heraclitus

This is my fifty-fifth monthly portfolio update. I complete this regular update to check progress against my goal.

Portfolio goal

My objective is to reach a portfolio of $2,585,000 by 31 July 2022. This would produce a real annual income of about $90,500 (in 2021 dollars).

This portfolio objective is based on an assumed safe withdrawal rate of 3.5 per cent.

Portfolio summary

Vanguard Lifestrategy High Growth Fund	$861,242
Vanguard Lifestrategy Growth Fund	$46,541
Vanguard Lifestrategy Balanced Fund	$83,858
Vanguard Diversified Bonds Fund	$100,821
Vanguard Australian Shares ETF (VAS)	$339,296
Vanguard International Shares ETF (VGS)	$185,504
Betashares Australia 200 ETF (A200)	$288,586
Telstra shares (TLS)	$2,004
Insurance Australia Group shares (IAG)	$6,537
NIB Holdings shares (NHF)	$7,812
Gold ETF (GOLD.ASX)	$106,302
Secured physical gold	$16,991
Plenti (P2P lending)	$3,076
Bitcoin	$518,680
Raiz app (Aggressive portfolio)	$21,032
Spaceship Voyager app (Index portfolio)	$3,409
BrickX (P2P rental real estate)	$4,552
Total portfolio value	$2,596,243 (+$63,666)

Asset allocation

Australian shares	38.7%
Global shares	22.7%
Emerging market shares	1.8%
International small companies	2.3%
Total international shares	26.8%
Total shares	65.5% (-9.5%)
Total property securities	0.2% (+0.2%)
Australian bonds	3.0%
International bonds	6.5%
Total bonds	9.5% (-5.5%)
Gold	4.7%
Bitcoin	20.0%
Gold and alternatives	24.7% (+14.7%)

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

Comments

The portfolio has gained around $63,000 over this past month. This has meant a partial recovery from the steep falls experienced last month.

All elements of the portfolio contributed to this return to growth, except for a small fall in the value of gold holdings.

Over the month the portfolio has increased by a total of 2.5 per cent. This growth means that the portfolio is once again operating just above the final portfolio goal, following it first reaching that level in late December 2020, and spending some time above it through the early part of this year.

Once again the equity component of the portfolio grew this month, increasing by around $60,000. This pushed forward the equity portfolio to two significant milestones.

First, the Australian equity portfolio has broken the $1,000,000 mark. By way of comparison, Australian equities represented $280,000 at the beginning of this record in early 2017.

Second, the total equity portfolio – including global equities – has now reached $1.7 million, or 88 per cent of the intended target allocation (of $1.9 million, or around 75 per cent of the total portfolio goal).

The value of Australian equities grew by around 2.0 per cent, and the value of international shares increased by around 4.3 per cent over the month.

The investments this month were again split across the Australian shares exchange traded fund (ETF) (ASX code VAS) and the Vanguard global shares (VGS) fund.

Over the next several days distributions will be finalised across key parts of the portfolio holdings.

The most significant drivers of the July distributions will be the three exchange traded funds (VAS, A200 and VGS), as well as the legacy Vanguard high growth retail managed fund.

Together these can be expected to make up around 80 per cent of the distributions, based on past data. Early indications across the estimated ETF distribution announcements are for payments relatively close to historical norms.

The major movement in Bitcoin this month has arisen as China seeks to ban Bitcoin mining across several provinces. This month also saw an extraordinary 12,000 people attend Bitcoin 2021, which featured many speakers from the Bitcoin community, and culminated in the announcement that El Salvador would legislate to adopt Bitcoin as legal tender alongside the US dollar. As ever, opinions sharply differ on the future.

These differing opinions also were well in evidence in an intriguing feature piece this week on the cryptocurrency media website Cointelegraph focusing on the FIRE movement and cryptocurrency, a piece that discussed the role of Bitcoin in my own FI journey.

Trends in Bond allocations: deviations from the course

At the close of the financial year, one of the most persistent trends which has become evident is the falling of the portfolio bond allocation below its target of 15 per cent.

Bond allocations in the portfolio have trended below the target allocation since September 2019. This due to several causes. First, no new investment in bonds as an asset class have been made since May 2018.

A long-term view of the evolution of the level of the bond portfolio, and its significance in the portfolio is set out in the chart below. Since reaching a brief high of 30 per cent of the portfolio in 2014, the allocation as drifted lower to its current value of 9.5 per cent.

Since mid-2018 all investments have been directed to Australian or global equites, and as the portfolio overall has grown, the bond allocation has proportionally been reduced. Further, some of the capital gains in bonds held in Vanguard retail funds and distributed have been redirected to equity investments.

This means that in nominal dollar terms, the actual amount of bonds held have been virtually unchanged over the past two and a half years, at around $250,000.

Over the past two months, a significant threshold was also crossed where the ‘dollar gap’ between the notional target allocation to bonds in the plan (around $380,000), and the actual bond holdings was larger than the gaps between target and actual allocations to either Australian or global equities.

Applying the target allocation in the portfolio plan, this means I should be strongly considering directing new investments to bonds.

There is a forceful pull to do so, from the academic findings that asset allocation decisions dominate security selection in determining portfolio volatility, and the risk-reducing benefits of pursuing a portfolio made up of individual uncorrelated assets.

My predisposition is to follow rules-based approaches, that remove discretion and active management (and the errors it inevitably creates) from portfolio choices. Moreover, closeness to the portfolio target, and falling in the ‘retirement danger zone‘ would also suggest some caution.

Yet I have not made this choice, in this case. Why? In my personal circumstances, my principal reasons are:

• Bond yields do not carry a material likelihood of exceeding inflation and delivering real returns – Corporate bond yields are currently narrow in historical terms, and recently Australian and international bond issuances have featured negative nominal yields. That is, the lender pays the borrower for the privilege of lending funds for future, uncertain, repayment. Under a wide range of expected inflation outcomes, bond-holders can expect zero, or negative real returns.
• There is the significant potential of capital loss at current bond valuations – Bonds have delivered out-sized returns compared to their longer-term historical averages over the past four decades. This has resulted from capital appreciation from persistently falling interest rates. Unless deeply negative rates are to be a feature of the future, there is simply little room for further capital appreciation, with current rates at or near historical lows. In this environment, increases in interest rates will deliver a headwind, or capital losses, to future bond returns.
• Substantial central bank purchasing of government bonds is likely to be distorting the market performance and price of bonds – Globally, and in Australia, central banks are undertaking ‘quantitative easing’ and other policies which artificially suppress the yield on key benchmark bonds, and which allow for purchasing of these bonds in the secondary market, affecting price discovery and assessments of fair asset values.
• Central bank ownership of government bonds introduces unquantifiable policy risk into their performance – Linked to the above, once central banks have government bonds on their balance sheet, future prices and values become subject to uncertain policy risks around the circumstances and timing of any disposals.
• It is unclear whether bonds maintain the same ‘diversification’ benefit – Historically over the past century, bonds have typically provided a diversification benefit by increasing in value in equity market falls. This relationship is less clear than in the past.
• Government benefits potentially represent a default bond allocation – Any future pension entitlements, which would have a greater chance of being accessed where the portfolio has underperformed, effectively form a kind of unreported ‘bedrock’ bond allocation. This means that the entitlements effectively represent an ‘invisible’ personal bond allocation, albeit with some level of uncertainty, that is not reported in these updates, but which affects overall risk.

Each of these are relatively persistent reasons for doubting that continuing to target an allocation of 15 per cent is appropriate in foreseeable market conditions. This means that I will aim to re-evaluate the broad asset allocation plan in light of these factors in January 2022, and continue to allow departures from the target allocation to grow wider.

A key part of this record is to set out the basis of portfolio decisions – whether they turn out to be correct or errors.

This supports deliberation, transparency and clear reasoning, as well as enabling learning, and avoiding ‘hindsight bias’. So the choice made may turn out to be the wrong one, for reasons I have missed. And that too will be part of the process and learnings along the journey.

Trends in average distributions and expenses

The trends in average distributions and expenses remain intact, for now.

The three year average of both distributions and credit card expenses once again continued to track lower this month, as illustrated in the chart below.

Depending on the level of distributions finalised and received over coming weeks, this may change.

This is because to build the average distributions series, contained in the chart above I need to estimate the likely level of distributions for the (now) 11 months since the July 2020 distributions.

The assumption I make about these assumptions is that they reflect the median level of distributions for the number of ETF and managed fund units to date. This means that to the extent distributions as a whole are above or below this median, some of the data points underlying the blue line above (around 11 of 36 points) will change.

The significance or otherwise of this will all become evident next month. In the mean time, credit card expenditure and distributions are maintaining their apparent tracking to around $5,000 per month.

Progress

Measure	Portfolio	All Assets
Portfolio objective – $2,585,000 (or $90,500 pa)	100.4%	130.2%
Total average expenses (2013-) – $85,000 pa	106.9%	138.6%

Summary

The journey has entered into a peculiar phase where the movements of markets can easily result in the portfolio catching a gust – rising well beyond the target – or a downdraft, falling below. This is linked to the choice highlighted above, to not build a large bond allocation for this phase.

The formal target date for the portfolio to reach financial independence is now less than 400 days away. For perhaps the first time, this feels pressing, less abstract, even as volatility makes the date more symbolic than substantive.

Rather, what comes into perspective at this point of the journey is the struggle between the motive forces of markets and habits. These interlock, sometimes battling and sometimes reinforcing each other. Over time, sustained small increases in the valuation of Australian and global equities can erase the distance to travel.

A day or two of Bitcoin price level changes can do the same. Yet closer to the end of 20 years of investing, the direct mathematical impact of habit slackens, and an invisible transition occurs where ones fates fall largely into the hands of markets.

This month my reading has focused on history, including re-reading The Downfall of Money, and discovering a copy of the autobiography of former German central banker, and for a short time Hitler’s economic czar, Hjalmar Schadt. Together these works cover the national trauma of the post-World War 1 period in Germany, hyperinflation, and its aftermath and contribution to condition leading to a Second World War.

What is striking in the narrative is the capacity for communities and nations to slide into extraordinary conditions, which change the moral relationships between citizens and the state for generations, by a sequential series of poor policy choices. Conditions such as hyperinflation at first glance appear unimaginably remote today. Yet they seemed so also, to those people eventually struck by them across the early 1920s an mid-1940s.

While there is value in understanding how the improbable can become reality, there are a relatively limited set of practical actions that can be taken to forestall such disasters. A monthly habit of investing into real wealth generating or preserving assets, both within one’s country and beyond is one concrete step that can be taken. By habits and choices, day by day or month by month we can make our future selves appreciably more resilient to even improbable futures.