Time forks perpetually towards innumerable futures

Jorge Luis Borges, The Garden of Forking Paths

This is my sixty-fourth 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	$801,655
Vanguard Lifestrategy Growth Fund	$42,562
Vanguard Lifestrategy Balanced Fund	$76,143
Vanguard Diversified Bonds Fund	$93,082
Vanguard Australian Shares ETF (VAS)	$400,699
Vanguard International Shares ETF (VGS)	$305,098
Betashares Australia 200 ETF (A200)	$300,813
Telstra shares (TLS)	$2,110
Insurance Australia Group shares (IAG)	$5,549
NIB Holdings shares (NHF)	$7,632
Gold ETF (GOLD.ASX)	$116,270
Secured physical gold	$18,552
Plenti (P2P lending)	$28
Bitcoin	$697,880
Raiz app (Aggressive portfolio)	$20,594
Spaceship Voyager app (Index portfolio)	$3,329
BrickX (P2P rental real estate)	$4,707
Total portfolio value	$2,896,703 (+$190,975)

Asset allocation

Australian shares	36.3%
Global shares	23.5%
Emerging market shares	1.5%
International small companies	1.9%
Total international shares	26.9%
Total shares	63.3% (-16.7%)
Total property securities	0.2% (+0.2%)
Australian bonds	2.4%
International bonds	5.4%
Total bonds	7.8% (+2.8%)
Gold	4.7%
Bitcoin	24.1%
Gold and alternatives	28.7% (+13.7%)

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

Comments

This month the portfolio has increased by around $191,000, or around 7.1 per cent, which is the strongest performance in the past five months. This breaks the run of two relatively flat monthly outcomes since the beginning of the year.

Stepping back, this growth means that the portfolio now sits at approximately double the level reached three years ago, even though it has only just recovered to the level reach at the end of last August.

The portfolio continues to be above the revised portfolio goal of $2.62 million.

A major reversal in the price of Bitcoin occurred over the past month, with its value rising around 19 per cent. This has delivered over half of the total portfolio gains made since last month.

The other significant source of growth was a 7.0 per cent advance in the value of Australian shares. Despite a poor start to the month, international equity investments gained around 2.2 per cent. This brought the value of total equity holdings to above $1.8 million, returning equities overall to close to their highest ever level.

By contrast, the value of gold assets held fell by 3.5 per cent, and bond holdings also suffered significant capital losses – of 2.5 per cent – as yields rise. This continues to leave the overall bond portfolio at the lowest levels last experienced in 2016.

Through this month the economic impacts of global supply chain problems and the invasion of Ukraine continued to interact to deliver volatility on global debt and equity markets.

Globally, inflation rates are increasing, and the US Federal Reserve moved to increase its base interest rate through the month, as inflation outcomes continued to worsen in the US.

Markets seem to be seeking to understand and adjust to the potential combination of higher interest rates and inflation, a damaging mixture not experienced since the stagflation period of the 1970s, and subsequent moves by the US Federal Reserve to break the back of persistently high inflation in the early 1980s.

Through the financial news, the month has seen a number of what would previously have been extraordinary stories in their own right slip by.

One example is Russia signalling a potential move to back its stumbling currency with gold, and accept gold and Bitcoin for oil exports. Another is the United States effectively ‘sterilising’ another nation’s central bank holdings of the principal global ‘risk-free’ asset – US Treasury bonds. The US yield curve has started to invert, which has historically pointed to economic weakness.

All this points to a need to be aware of the potential for developments outside of the scope of standard expectations.

The continued relatively weaker performance of global shares compared to Australia equities, has led to investments this month continuing to be directed toward Vanguard’s global shares ETF (VGS). This is done with the medium-term objective of reaching an equal allocation of Australian and international equities.

This month I was delighted to be amongst Australian FIRE seekers profiled in the April edition of Money magazine, which provided a fascinating update on the Australian financial independence movement through and following the pandemic.

As the month closes, likely quarterly distributions from the portfolio have become clearer. First quarter distributions a few years years ago tended to be dominated by episodic and variable payouts from the Vanguard diversified bonds retail index fund.

With the recent growth in the exchange traded fund component of the portfolio, this has changed.

Based on early guidance on ETF distributions, and past averages of the Vanguard bond fund, the chart below provides a current estimate of first quarter portfolio distributions for 2022.

This should see first quarter distributions of around $12,500, which is the highest on record, due to relatively high distributions from the Australian shares ETFs held (VAS and A200).

Around a third of these payouts will be quarantined for future taxation liabilities, with the remainder re-invested through next month.

Inflation and stock returns: evidence from 1900-2021

Across many developed economies inflation is now re-emerging strongly.

This raises the question of how to protect purchasing power and the performance of asset classes in different inflation regimes.

A position frequently put is that equities represent an ‘inflation hedge’.

The intuitive basis of this is clear enough: firms facing increased costs can sometimes pass some of these costs on to their customers, effectively protecting the ‘real’ value of the equity stake in a firm represented by a single share.

The clearest contrast is to bonds and fixed interest, with promised future nominal dollar payments, where the real value these payments is effectively eroded by any higher than expected inflation.

The most recent Credit Suisse Global Investment Yearbook released last month puts some useful historical data and analysis around this common proposition, drawing from a dataset of 21 countries over 120 years of bond and equity prices.

In turn, this dataset provides around 2,500 historical observations, allowing comparisons of typical asset return experiences across times of both low and high inflation, as well as deflation (price declines).

The findings are worth reviewing in detail, but broadly stated are:

• Average real returns from bonds are generally harmed by inflation, but typically are higher during periods of deflation

• Equities tended to underperform bonds in those periods of strong deflation reviewed, even while delivering strong returns (12.9 per cent compared to 19.2 per cent in deflationary times)

• Over all other inflationary regimes more commonly experienced – mild deflation to high inflation – equities outperformed bonds, noting that both bond and equity returns were negative in the highest inflationary periods

• Real equity returns are strongest in low inflation periods, and worse during higher inflation periods

• Consequently, this suggests there is a negative correlation between equity returns and inflation – that is, equities have historically been a poor hedge.

As the paper observes, a range of academic finance studies reinforce this last point, with the negative correlation dubbed ‘one of the most commonly accepted empirical facts in finance‘ by one prominent study.

This emphasises that an asset beating inflation is not the same thing as providing a hedge against inflation, the two are subtly different concepts.

The review concludes that the strong record of equities in preserving wealth in real terms is therefore likely a product of the earned ‘equity risk premium’ (i.e. the compensation for risk), rather than being a result of equities hedging inflation especially well.

Trends in average distributions and expenses

Average portfolio distributions continue to track around $1,300 per month above average total expenses.

At the moment both three-year average total expenses and distributions are falling.

The blue line of distributions continues to track at just below $7,400 per month. The total expenses (red) line fell to around $6,100.

Broadly total expenses have been in a downward trend from a maximum level of around $7,700 in 2017, but may now be bottoming out – with there being fewer opportunities for easy to achieve savings as earlier in the journey.

By contrast, the distributions payments have recently reached their maximum, and have started to drift lower, as some unusually high distributions over some previous periods leave the sample set.

Progress

Measure	Portfolio	All Assets
Portfolio objective – $2,620,000 (or $91,600 pa)	111%	141%
Total average expenses (2013-present) – $84,400 pa	120%	154%
Target equity holding in portfolio – $2,100,000	87%	N/A

Summary

As the portfolio has grown, there is an interesting dual effect which is observable on a monthly basis.

While the absolute dollar volatility rises inexorably with the size of investments – at times amplified by Bitcoin holdings – size also begins to exert a secondary effect. This is an offsetting tendency for even large absolute movements being less able to shift the overall shape of the portfolio as easily as before.

For the past twelve months, the portfolio has oscillated in a range of around $2.7 to $3.0 million, less some months, more during others. This is equivalent to being just above the final target portfolio, to comfortably above it.

Such periods of relative sideways movement in the portfolio are not unusual in the journey, and have occurred even quite recently – with the whole of 2018 being an example.

Yet in the past continued investment during these times has provided a springboard for any eventual forward movement, meaning the exit from these flat periods is often quite sharp.

Amongst this oscillation smaller – perhaps arbitrary – markers along the way also continue to provide additional signs of progress. One this month has been reaching a total of $1.0 million in exchange traded funds alone, an avenue of investing not even properly explored until mid-2017.

This month I have been watching an excellent SBS On Demand series called Payday, about a number of American and Canadians’ day to day relationships with money, income and wealth, and how it shapes their daily lives. I’ve also enjoyed reading blogger Adventures with Poopsie’s reflections on the surprises of post-FI life.

The podcast The Long View has also had a fascinating interview with Dr Andrew Lo, a prominent academic contributor to modern finance theory, discussing the never ending search for the ‘perfect’ portfolio. At the geo-political level of finance, the recent discussion between Grant Williams and Luke Gromen also provided a unique perspective on what the economic sanctions placed on Russia and its central bank assets could mean for the global asset market developments.

The Chris Nolan film Tenet made its way to the top of my watch list this past week. It explores the concepts involved in people moving simultaneously backwards and forwards through time. Looking at global market and monetary policy developments today, there is a similar eerie sense of dislocated time.

Major European capitals are gripped in war and central banks are being forced into extraordinary action to preserve a fragile sense of normalcy in markets. Effective financial repression – along the lines of that imposed on 1940s bond markets through various yield controls – appears to be waiting in the wings.

The philosopher Kierkegaard observed that life can be understood backwards, but must be lived forwards. And the same is probably true of portfolio developments.

Only in retrospect, looking back after the fact, will the true significance or inconsequence of this brief period be revealed. From here, time does fork into innumerable futures.

Disclaimer

The specific portfolio allocation and approach described has been determined solely based on my personal circumstances, objectives, assessments and risk tolerances. It is not personal financial advice, or recommendation to invest in any particular investment product, security or asset, and investors considering these issues should undertake their own detailed research or seek professional advice.