The sea washes across the decks and maststep

And dark daylight already shows through long rents in the sails

Alcaeus, Fragments

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

Portfolio goal

My objective is to maintain a portfolio of at least $2,620,000 through 2022. This should be capable of producing an annual income from total portfolio returns of about $91,600 (in 2022 dollars).

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

A secondary focus through 2022 will be achieving the minimum equity target of $2,100,000.

Portfolio summary

Vanguard Lifestrategy High Growth Fund	$790,086
Vanguard Lifestrategy Growth Fund	$42,487
Vanguard Lifestrategy Balanced Fund	$76,957
Vanguard Diversified Bonds Fund	$97,297
Vanguard Australian Shares ETF (VAS)	$367,311
Vanguard International Shares ETF (VGS)	$288,466
Betashares Australia 200 ETF (A200)	$274,868
Telstra shares (TLS)	$2,089
Insurance Australia Group shares (IAG)	$5,372
NIB Holdings shares (NHF)	$7,476
Gold ETF (GOLD.ASX)	$115,439
Secured physical gold	$18,425
Plenti (P2P lending)	$56
Bitcoin	$586,560
Raiz app (Aggressive portfolio)	$20,463
Spaceship Voyager app (Index portfolio)	$3,459
BrickX (P2P rental real estate)	$4,997
Total portfolio value	$2,701,808 (-$246,827)

Asset allocation

Australian shares	36.6%
Global shares	24.4%
Emerging market shares	1.6%
International small companies	2.0%
Total international shares	28.1%
Total shares	64.6% (-15.4%)
Total property securities	0.2% (+0.2%)
Australian bonds	2.6%
International bonds	5.9%
Total bonds	8.5% (+3.5%)
Gold	5.0%
Bitcoin	21.7%
Gold and alternatives	26.7% (+11.7%)

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

Comments

Over the past month the portfolio has witnessed its largest ever nominal dollar loss, of around $247,000.

This represents a decline of 8.4 per cent in the portfolio, which is the second largest percentage fall after March 2020. It has pushed the portfolio down to levels of around six months ago, notionally at least undoing all progress since winter.

Despite this, the portfolio still – narrowly – sits above the revised portfolio goal of $2.62 million

The story of the month was of simultaneous waves from west and east, to borrow another phrase from the Greek poet Alcaeus. Sharp falls in equity markets through January and continued falls in the value of bitcoin for most of the month contributed in nearly equal parts to the final result.

Australian shares fell around 5.5 per cent for the month. Global equity holdings also declined in value by around 4.5 per cent.

Increasing market conviction around future US interest rate rises also saw the value of bond holdings simultaneously fall, with relatively large losses incurred – of about 1.9 per cent.

The only bright spot in the portfolio was gold holdings, which increased in value by nearly 1.6 per cent to reach levels not experienced since November 2020.

Broadly, however, what can be seen in the chart below is what occurs when multiple asset classes exhibit at least short-term correlation, each responding to perceptions of sharply changed market conditions.

A key driver of portfolio outcomes this month were equity market reactions to changing guidance from the US Federal Reserve on the possible future of interest rates. In turn, this resulted in a reassessment by many of the performance outlook for growth-based technology companies which currently dominate US equity indexes.

The falls in Australian and global shares this month may have been an unlooked for wave, but their relative sizes perversely assisted in the medium-term rebalancing strategy between domestic and international equities.

This month continuing this strategy meant the allocation of new investments, including some of the recently paid December quarter dividends, to Vanguard global shares (VGS) exchange fund.

Equity and bitcoin correlation: moved by the same current?

In this shifting environment simultaneous downward movements in bitcoin has turned focus towards the higher positive correlation experienced between bitcoin and US equities over the past year. This has led to some commentators positing (video) that bitcoin is more akin to an interest-rate sensitive technology stock than ‘digital gold’ or an emergent store of value.

This is possible, however, defining the likely risk characteristics of an asset which has been traded for more than 11 years from its behaviour over a less than two year period seems a potentially quite crude exercise in extrapolation, rather than conclusive analysis. The popular claim appears to have evolved from the inevitable demise of bitcoin, to it now assuming a more stable and understood role within macro-economic impacted asset markets – as a high beta ‘tech stock’ like instrument.

It is unclear this latter claim is any sounder than the former – or even its relevance if correct.

Looking at bitcoin’s correlation to my largest single asset holding, Australian equities, over the past 2.5 years, for example, shows extended and alternating periods of negative and positive correlation. There has been an increase in overall correlation measured through the entire period, from about 0.1 to just under 0.4.

Yet only a further short period of uncorrelated trading – such as that experienced in late 2019 – would be needed to destroy this fragile trend. This means it is simply too early to conclude that bitcoin has permanently evolved into a predictably high-correlation ‘risk on’ asset class.

Taking a wider view of portfolio risk and strategy: practice and theory

One of my close interests is the intersection of traditional finance theory, and the practical realities of seeking to plan, construct and manage a financial independence portfolio.

Theory in this area can be slow-moving, after the asset pricing revolution in finance of the 1950s to the 1970s. Many key ideas from this phase are still only reaching retail and other investors, and influencing their day-to-day practice.

This month I was pleased to come across an open source version of a 2021 paper (pdf) by the noted Stanford financial economist, and former University of Chicago professor, John H. Cochrane on Portfolios for Long-term Investors.

The paper is long, but worth reading in full (though some of the maths can be skipped). It poses interesting questions around the relationship between both theoretical and empirical finance and the actual execution of investment by real-world investors.

Translating theory into practice: some challenges

While broadly supporting passive index-style investing, some of the ideas of the paper challenge all investors to think anew about some less frequently discussed aspects of combining theory and practice.

For example, he proposes:

• Questioning the simple ‘income as a bond’ view – The traditional financial planning view of future wage income as having strong ‘bond-like’ qualities may be overstated or incorrect in some cases – meaning further thought is needed about the real characteristics of individuals income.

• Having clearly set out reasons for market-index departure – Investors need to have a clear and compelling rationale for every material departure from a broadly diversified market portfolio – and the suggestion that investors – as a class – can benefit from ‘growth’ or ‘value’ tilts is often not a coherent claim when considered the individual level.

• Remembering individual risks – Many investors would benefit more by thoughtful consideration of how to hedge their own specific risk circumstances (for example, risks to their income, or risks arising from asset concentration) than by spending time seeking to outperform the market.

• Houses may not be as ‘safe as houses‘ – Most home owners sit on a ‘non-traded, highly leveraged, illiquid asset chock full‘ of risk, and this should also form part of long-term investment considerations.

The paper also helpfully suggests three tests for portfolio construction: the placebo test (why should you hold a portfolio different than the market?), the ‘look in the mirror‘ test (ask the question of why there is another party to any trade you make), and the ‘dinner with lions‘ test (be sure one is not the dinner).

In some sense his thesis challenges a reflexive unthinking ‘buy-and-hold’ dollar-cost averaging approach, by asking the investor to more consciously consider, in his words: “What are the risks of this security, why are others unwilling to hold that risk, and why am I the right person to do so?“.

In practice, a well-thought out investment plan should address those questions, as well as others such as the time-frame for investment and risk appetite and capacity.

Trends in average distributions and expenses

Average distributions continue to comfortably move ahead of average total expenses.

On a three year moving average basis, both total and credit card expenses continue to fall, increasingly reflecting the lower patterns of expenditure during phases of lockdowns and other restrictions. Meanwhile, average distributions continue to rise.

From this, it can be seen from the chart below that from around April of last year distributions surpassed average total expenditure, and have remained growing.

The blue line of distributions continues to track above $7,400 per month. The total expenses (red) line, by contrast, continues to fall to a monthly average of around $6,100.

While the annualised value of total expenditure tracked here is lower (at $73,000) than both average expenditure since 2013 ($84,500), and the portfolio income target ($91,600), the gap between distributions and expenses continues to represent a welcome margin of safety, visible in real-time.

Over time I expect this gap to stabilise, and potentially even close slightly, as the period of the most significant restrictions move through the data set used to estimate the moving average, and eventually drops away.

Progress

Measure	Portfolio	All Assets
Portfolio objective – $2,620,000 (or $91,600 pa)	103%	133%
Total average expenses (2013-present) – $84,500 pa	112%	144%
Target equity holding in portfolio – $2,100,000	83%	N/A

Summary

These past two months have seen the most significant total dollar losses of the journey so far.

Yet in contrast to other similar downturns these losses have largely occurred during a lengthy period of genuine extended rest and holidays, interspersed with some days of work.

Last month I observed that I was satisfied with the current allocation as a reasonable one with which to meet an unknown future. This remains the case, in spite of equity markets finally re-discovering that capacity for volatility that is a feature of their existence. I have not experienced any particular discomfort or anxiety from the volatility through this month.

Indeed, even at this stage of the journey I still find myself pleased to be able to buy a greater number of ETF units – due to these falls – than just a few weeks ago. Partly this must be muscle memory from the journey, as the equity acquisition task is (barring any extraordinary events) more than half complete, meaning that such falls in actuality damage more than help.

This makes the issue discussed above – the future relationship between equity risk and bitcoin – of more than just theoretical interest.

To the extent that the correlation may have changed, as a result of greater institutional adoption, this appears to be net positive for its future prospects and underlying price stability, even if it makes bitcoin’s specific risk characteristics less valuable than I may have previously hoped.

Only time, and experience with different interest rate and inflation regimes will ultimately resolve this open question. As this post by NYU Professor of Finance Aswath Damodaran highlights, asset class returns are also affected differently based on whether inflation is expected, or unexpected.

A luxury this month has been more time to read and listen to many books. I have been simultaneously enjoying a heterodox history of global monetary history Super Imperialism by Michael Hudson, as well as a rare fictional work by Neal Stephenson called Snowcrash – about a dystopian future California and featuring an early depiction the concept of the ‘metaverse’.

Finally, I have been rereading Capital Ideas Evolving, a history of efforts of investment practitioners and firms to put into practice key ideas from modern portfolio theory. A remarkable thing is that these findings of conventional theory are now fairly freely available to all investors with an internet connection, as this three secrets of an efficient portfolio article recently posted on Reddit shows.

A small marker on the journey was passed with the publishing of this update – the reaching of a total of 100 blog posts. Most are monthly portfolio updates, like this one, reporting the vagaries and movements of markets.

The marker and record shows that even as financial progress may seem reversed, other elements of life can persist, grow and in their own way compound – and that when it comes to the portfolio, dark daylight can eventually shine through even wind-torn sails.