Till noon we quietly sailed on,

Yet never a breeze did breathe:

Slowly and smoothly went the ship,

Moved onward from beneath.

Samuel Taylor Coleridge, The Rime of the Ancient Mariner, Part V

This is my fifty-sixth 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	$810,231
Vanguard Lifestrategy Growth Fund	$43,713
Vanguard Lifestrategy Balanced Fund	$79,464
Vanguard Diversified Bonds Fund	$101,270
Vanguard Australian Shares ETF (VAS)	$351,101
Vanguard International Shares ETF (VGS)	$200,090
Betashares Australia 200 ETF (A200)	$290,938
Telstra shares (TLS)	$2,014
Insurance Australia Group shares (IAG)	$6,144
NIB Holdings shares (NHF)	$8,568
Gold ETF (GOLD.ASX)	$112,261
Secured physical gold	$17,980
Plenti (P2P lending)	$1,918
Bitcoin	$628,750
Raiz app (Aggressive portfolio)	$21,014
Spaceship Voyager app (Index portfolio)	$3,412
BrickX (P2P rental real estate)	$4,558
Total portfolio value	$2,683,426 (+$87,183)

Asset allocation

Australian shares	37.2%
Global shares	21.7%
Emerging market shares	1.7%
International small companies	2.1%
Total international shares	25.4%
Total shares	62.6% (-12.4%)
Total property securities	0.2% (+0.2%)
Australian bonds	2.8%
International bonds	6.1%
Total bonds	8.9% (-6.1%)
Gold	4.9%
Bitcoin	23.4%
Gold and alternatives	28.3% (+18.3%)

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

Comments

The financial independence portfolio has grown by just over $87,000 since the last monthly update, or around 3.2 per cent.

This means that it continues to sit notionally above the portfolio goal, and expand, tracking towards its previous highs.

Yet this month has some peculiarities that affect the interpretation of these results.

The portfolio distributions received from the second quarter have led to a notional decrease in the level of equity holdings, because these have not immediately been reinvested.

In reality, around $52,000 of these distributions are aside in cash. They have yet to be put back into the portfolio, and are not recorded in the portfolio report.

Rather, these will continue to be placed into equity exchange traded funds (ETFs) on a fortnightly basis through to December, balanced between Vanguard’s Australian shares (VAS) and international shares funds (VGS).

This process will represent a significant underlying current pulling the portfolio in a positive direction over the next five months. For the current month, however, it means that the headline monthly portfolio movement is somewhat artificially lowered, and the absolute value of the equity portfolio is actually temporarily lower than a month ago.

With these caveats, there was price growth of 2.5 per cent in the international shares holdings, and Australian equities also increased in price by just less than 1.0 per cent. As a result, total equities holdings now sit at around 87 per cent of the intended target allocation (of $1.9 million, or around 75 per cent of the total portfolio goal).

Gold increased in value by around 5.3 per cent as global interest rates recommenced a downward movement, and bonds also increased in total value, despite their second quarter distributions.

The single largest positive contributor to the portfolio movement was once again Bitcoin, where holdings grew in value by over 17 per cent or $90,000.

The reinvestments of distributions this month were again split across the Australian shares exchange traded fund (VAS) and the Vanguard global shares (VGS) fund.

Vanguard FIRE analysis – updating the ‘4 per cent rule’

Last month global index fund provider Vanguard released an interesting report (pdf) directly relevant to seekers of financial independence and early retirement.

The report re-examines and analyses some of the assumptions and simplifications of the original Bengen work that developed the so-called ‘4 per cent rule’.

The Vanguard analysis highlights some hidden risks for those pursuing FI in some of the underpinnings of the original study, and seeks to provide some suggested ways to manage these risks. Some of its key findings are:

• Relying on historical return estimates can create risk – and that potentially lower forward-looking market returns should be considered in safe withdrawal rate estimates.

• Over periods longer than 30 years, the success of a 4 per cent safe withdrawal rate drops – a relatively well-known critique of the original 1994 study.

• Fees matter – here, the important finding is that the original Bengen study assumed away investment fees, but that even relatively low fees (0.2 per cent) can lower the probability of success materially compared to the original findings/

• International diversification can help lift success rates – in the example given (US-based), international diversification helps lift the success rate from 36 to 56 per cent.

• Adopting a ‘dynamic spending rule’ should be considered – there are a myriad number of variations to the potential suitable rule, but essentially a dynamic spending rule reduces withdrawals in response to adverse market outcomes, and lifts withdrawals (within constraints) in cases of positive market outcomes.

This report is one of the best brief treatments of the 4 per cent rule I have seen published by an investment firm. Given my own average investment fees across the portfolio sit at around 0.22 per cent, its findings on the easily overlooked impact of small fees was a matter for some reflection.

Laying down new stores: an emergency fund reconsidered

This journey is now exactly one year from the revised target for its close.

At this stage, while finishing paid work is not yet on the immediate horizon, a couple of issues press their way forward for attention. The first is avoidance of sequence of return risk, and the second is the evolution in the role and functioning of an emergency fund, or ‘cash cushion’.

The post last month discussed why even sequence of return concerns were not sufficient reason in my personal circumstances to continue to actively target bonds with new investment.

This potentially places even more weight and attention on the issue: what level of cash reserves are appropriate for the eventual transition to financial independence?

In terms of a starting point, an emergency reserve of $21,000 is already in place today.

At one time, this was a full year of expenses. It was principally designed to serve as a protection again major life events, such as unexpected job loss.

Over time, as distributions income has increased, this has been reduced. The target has been for the sum of average annual distributions and the emergency reserve to remain equivalent to a full year of average expenses.

New functions and requirements for a cash reserve?

Yet for the movement to more secure financial independence, beyond accumulation towards the target, arguably a different type of cash reserve is called for. A reserve to serve two distinct purposes.

First, to represent a floating amount to ‘smooth out’ timing mismatches between highly variable quarterly and half yearly distributions.

Second, to provide the option of drawing down cash reserves, rather than selling assets at a time when markets prices have fallen significantly.

For a long time, the debates that occurred about ‘cash cushions’ in the financial independence arena seemed rather distant and theoretic to me.

Opinions differed between well known ‘bucket’ approaches, to quite persuasive critiques of these approaches, such as the suggestion that cash reserves provided an expensive and false sense of security, and that their role in avoiding sequence of return risk was illusory.

A third potential purpose is to serve as an emergency fund for large potential expenditures, but without the loss of employment forming the definition of the emergency to be mitigated.

It is clearly now time to start thinking about this issue in more concrete terms.

My initial thinking is:

• A goal of one year of expenditure in reserve – Setting the level of desired emergency funds at $85,000, which is around the average of one year of expenditure since 2013;

• Supplemented by one-off capital expense fund – With a separate (already existing) lump-sum amount of around $16,000 for a major one-off unexpected area of capital expense; and

• Building in highly conservative distributions assumptions – Applying the minimum estimate of $22,600 in distributions per annum. This estimate is based on the lowest recorded historical rate of distribution across all major investments.

Adopting an estimate of feasible lowered expenditure during a period of market down-turn of around $48,000 it is possible to estimate how long such a reserve fund might last.

In this scenario, the fund would be exhausted by the first quarter of the fourth year.

This means that for four years no new investments would be made, and the dividends and distributed capital would be used to support living expenses, but that otherwise no investments would be required to be sold.

Trends in average distributions and expenses

The trends for average distributions and expenses have not materially changed this month, with one exception.

Finalisation of the half-yearly portfolio distributions in earlier July has enabled the replacement of estimated distributions over the past six months with the actual amounts received.

This has not changed the level of expenses, but means that the three-year rolling average of distributions is now sharply increasing.

This is in contrast to past months, where conservative median estimates of distributions contributed to the blue line of distributions following the credit card expenses (red) downwards.

The updated results are illustrated in the chart below.

This shows that about one year ago distributions decisively ‘crossed’ the line of card expenses, if three year averages are taken to be representative.

Card expenses continue to decline just below $5,000 per month, whilst average distributions are rising to around $7,000 per month.

Progress

Measure	Portfolio	All Assets
Portfolio objective – $2,585,000 (or $90,500 pa)	103.8%	133.6%
Total average expenses (2013-) – $84,700 pa	110.8%	142.6%

Summary

Most of this month it appeared that the portfolio would be delivering a small loss, driven by the delay in reinvesting a large set of distributions received in early July. To end the month positively is a surprise.

Progress and movement above the target, however, feels more abstract than progress towards a fixed end point. This is why my increasing focus has been on reaching the target level of equity holdings, which is still some distance away.

Nonethess, one significant marker was reached this month. For the first time on the journey, equities held directly or through exchange traded funds exceeded 50 per cent of total equities held.

This reflects the growing role since 2018 of ETFs, and no further investments being made in the Vanguard retail funds since that time. Passive index-based equity ETFs now make up almost one-third of total portfolio holdings.

A pleasing milestone of a different sort which was also reached this month, was this record of the journey passing 200,000 total page views.

From a total of around 14 views average per day when the journey started, four and a half years ago, this number feels hard to comprehend.

It means the equivalent of one person having sat down to continuously read the blog every day for 1000 days in a row, from morning through to the evening. This thought keeps my attention on seeking to write accurately and usefully about the personal journey, so as not to waste that hypothetical readers’ valuable time.

Financial markets continue to present apparent contradictions. The month has seen a significant downward turn in both government and some corporate bond yields. This is despite some signs of inflation not being quite as transitory, or solely supply chain related, as first suggested by some market commentators and authorities.

Equity markets still appear at precipitous levels, and in the past month even higher risk below investment grade corporate bonds have sold at negative yields. In some ways, there is a sense of large dynamic forces building up under the surface of financial markets.

Looking over the side, however, all appears calm and smooth. For the time being, the ship moves onward, pushed from beneath.