Tomorrow we’ll sail the wide seas again

Horace, Odes, Bk I:VII

This is my sixty-eighth 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	$714,803
Vanguard Lifestrategy Growth Fund	$38,546
Vanguard Lifestrategy Balanced Fund	$70,603
Vanguard Diversified Bonds Fund	$90,727
Vanguard Australian Shares ETF (VAS)	$355,563
Vanguard International Shares ETF (VGS)	$348,094
Betashares Australia 200 ETF (A200)	$268,999
Telstra shares (TLS)	$2,073
Insurance Australia Group shares (IAG)	$5,663
NIB Holdings shares (NHF)	$8,688
Gold ETF (GOLD.ASX)	$113,675
Secured physical gold	$18,168
Plenti (P2P lending)	$6
Bitcoin	$378,820
Raiz app (Aggressive portfolio)	$19,389
Spaceship Voyager app (Index portfolio)	$3,125
BrickX (P2P rental real estate)	$4,650
Total portfolio value	$2,441,592 (+100,776)

Asset allocation

Australian shares	38.6%
Global shares	28.1%
Emerging market shares	1.6%
International small companies	2.0%
Total international shares	31.7%
Total shares	70.2% (-9.8%)
Total property securities	0.2% (+0.2%)
Australian bonds	2.6%
International bonds	6.0%
Total bonds	8.6% (+3.6%)
Gold	5.4%
Bitcoin	15.5%
Gold and alternatives	20.9% (+5.9%)

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

Comments

This month the portfolio grew strongly, gaining around $100,000 following the three preceding consecutive months of large losses.

A growth of this size is a relatively unusual event in the record since 2017, having only happened around ten times previously. It is similar in size to the the recovery shortly after the March 2020 coronavirus induced market uncertainty.

The portfolio has grown by around 4.3 per cent, to recover to a level first reached across early 2021. It remains, however,well below the revised portfolio goal of $2.62 million at the end of the month.

The majority of gains over the month were caused by a 20 per cent increase in the price of Bitcoin, off June lows. These increases represented around two-thirds of the portfolio’s movement this month.

Both Australian and international equities also increased.

Global shares increased in value by 4.7 per cent through the month, with some of this gain likely related to the impact of a falling Australian dollars on the unhedged component. Australian equities increased by around 3 per cent.

At the same time, dividends of around three per cent were paid out in the case of Australian shares, and less than one per cent in the case of international equities. As these are generally held for regular reinvestment, this can introduce an apparent downward movement in the case of distribution months such as January and July.

Bonds continued a recent pattern of correlation with equities, rising in value around 3 per cent. Gold underwent a significant price decline this month, of around 4.5 per cent.

The month has been dominated by increasingly urgent interest rate increases in many developed country markets, and strengthening concern around the persistence of inflationary forces.

Central banks are moving from a relatively recent period of indicating comfort with inflation being outside of (i.e. above) target ranges to address previously very low inflation results, and a heavy reliance on ‘forward guidance’. Now, actions are the priority, following the emergence of increasing criticism of major monetary authorities being effectively behind the curve in addressing sharply rising inflation.

Global inflationary expectations by some forecasts and measures, however, continue to point toward expected moderation. Perhaps it is this which has allowed equity markets to recover from recent lows, even as the spectre of economic contraction is looming for the United States, and is a reality for China.

By happenstance, markets have mildly assisted the targetted medium-term objective of reaching an equal allocation of Australian and international equities, with international shares outperforming domestic shares in capital growth terms.

The gap remains, however, and so once again investments this month have continued to be focused on the Vanguard international shares ETF (VGS).

Understand the currents – capital and income in distributions

Following the high distributions reported this month the question arises: to what extent are these distributions true ‘passive income’? Or put another way: what is the role of capital gains in these distributions?

It is a question I have delved into before here, to seek to establish the true ‘income potential’ of the portfolio. Quite obviously, if a fund is regularly returning capital to the investor, it is at greater chance of being unable to sustain these payouts over longer periods of time.

In that sense, the income potential of a portfolio provides a different measure of the sustainable flow of cash thrown off by the investment in question.

The chart and data table below sets out the composition of each year of distributions over the past seven years of available records, divided into capital gains and investment income.

This is drawn from tax return data, and so the data follows – but does not exactly match – that reported in portfolio income updates.

As can be seen, capital gains have played an increasingly important role in the total level of distributions.

This is largely related to the structure and operation of the Vanguard retail funds, but not exclusively so. Investment income in a pure sense has risen steadily from around $20,000 per year, to nearly double that, on average, across the seven years measured.

The data for the last complete year for which records exist – financial year 2020-21, suggests this is continuing, but that year was one of rather exceptional payouts in both income and capital terms.

Splitting capital gain from income-based distributions: a different perspective

Another way to view the same question is to examine the proportion of the total distributions received that were in fact paid out capital gains.

The chart below does this, drawing on the same data.

This shows a slow upward trend towards an outcome in which routinely 35-55 per cent of total distributions received are in the form of paid out capital gains.

As the tax records for this year are finalised I will review how this data changes the picture.

Generally, the movement towards exclusively investing in more tax efficient exchange traded funds in recent years should ‘cap’ the overall level of paid out capital gains arising from the Vanguard funds in dollar terms.

To the extent the capital gains paid out go beyond the overall rate of income produced, the degree of capital gains should eventually moderate through time. Here, the recent trend of decline in the overall value of the Vanguard High Growth fund is also significant – it having declined by 17 per cent since July 2021.

Trends in average distributions and expenses

This month average total expenses (red line) stayed flat at about $6,200 while the moving average of distributions (the blue line) continued to rise to around $8,300.

This measure changes only relatively slowly through time.

Considering it in the light of the income and capital gains data provides an interesting new perspective. The above data suggests that, for example, around $45,000 of pure investment income per year has been produced by the portfolio over the past five years available.

This equates to around $3,800 per month.

In turn, this means that only around 62 per cent of total expenses have been met through income thrown off by the portfolio.

Yet, this is persumably somewhat a function of the smaller average size of the portfolio through that period. On a forward-looking basis, by contrast, a median distribution estimate for current holdings is around $73,000.

Progress

Measure	Portfolio	All Assets
Portfolio objective – $2,620,000 (or $91,600 pa)	93%	122%
Total average expenses (2013-present) – $84,300 pa	101%	133%
Target equity holding in portfolio – $2,100,000	82%	N/A

Summary

The growth that has come this month cannot obscure the larger trend over the past year of a stagnation in the overall ‘headline’ portfolio level.

Similar periods of apparent lack of progress have occurred before. The entire year of 2018 was one such period. The end of 2019 to the late 2020 was another, albeit punctuated by the rapid fall and recovery through that year.

An unvarnished truth is that where a portfolio stays at around the same level for a year or longer, it will not experience as many firsts, turning points, or moments of significance as a growing portfolio will.

That is, in a sense, a small price to be paid for the portfolio not being in those early periods of strong accumulation and growth, in which individual investor actions determine the growth or otherwise of the portfolio.

Yet, under the surface, there are slow shifts that may not be apparent.

One is that for every dollar in Vanguard fund, there is now $1.30 in equity-based exchange traded funds – compared to a 1:1 ratio a year ago. Another is that 57 per cent of all equity held is now held in exchange traded funds, compared to roughly equal amounts in July last year.

A further slower trend is increasing concentration in a few newer investment vehicles – a trend that may not be visible on visual inspection of the list all investments. In reality, the five biggest investment structures now make up over 85 per cent of the total portfolio fund. The same five investment vehicles accounted for only about 60 per cent of the portfolio in January 2017.

Finally, there is the slow and seemingly remorseless trend of declining bond values, and holdings, with the total dollar value of bonds held nearly 12 per cent lower now than a year ago – an astonishing volatility and performance for an asset class generally considered to be lower risk.

This month I have read with interest the Scottish Widows report on investing for retirement in a time of higher cost of living and lower wages growth. The real-world impacts of unexpectedly higher inflation on retirement and financial independence is an under-examined area, and the report moves some way to address this.

The last three months have been effectively a voyage backwards, in terms of outward appearance and numbers. This month provides a positive break to this, restoring some limited progress. As such, it reminds us that these are wild seas on which we are afloat. Today – this month – they treated us kindly. Yesterday, they drove us towards the rocks. And tomorrow, we shall sail them again.

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.