…it is sweet to see the sea from the land when you don’t have to sail any longer

Archippus

This is my fifty-eighth 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	$807,844
Vanguard Lifestrategy Growth Fund	$43,486
Vanguard Lifestrategy Balanced Fund	$78,870
Vanguard Diversified Bonds Fund	$99,943
Vanguard Australian Shares ETF (VAS)	$363,435
Vanguard International Shares ETF (VGS)	$233,181
Betashares Australia 200 ETF (A200)	$291,171
Telstra shares (TLS)	$2,094
Insurance Australia Group shares (IAG)	$6,233
NIB Holdings shares (NHF)	$8,364
Gold ETF (GOLD.ASX)	$108,834
Secured physical gold	$17,413
Plenti (P2P lending)	$1,145
Bitcoin	$669,910
Raiz app (Aggressive portfolio)	$20,705
Spaceship Voyager app (Index portfolio)	$3,442
BrickX (P2P rental real estate)	$5,033
Total portfolio value	$2,760,803 (-$84,855)

Asset allocation

Australian shares	36.6%
Global shares	22.2%
Emerging market shares	1.6%
International small companies	2.0%
Total international shares	25.8%
Total shares	62.4% (-12.6%)
Total property securities	0.2% (+0.2%)
Australian bonds	2.6%
International bonds	5.9%
Total bonds	8.5% (-6.5%)
Gold	4.6%
Bitcoin	24.3%
Gold and alternatives	28.8% (+18.8%)

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

Comments

The portfolio fell in value by around $85,000 this month, declining by just over 3.0 per cent.

Despite this, the portfolio remains for the moment above the formal portfolio goal, as it has since May. Taking a slightly longer view, the portfolio is still over 50 per cent larger today, than a year ago.

The declines this month were broad-based and across almost all of the portfolio.

The value of Bitcoin fell by around 9 per cent, while remaining firmly higher than at the start of the year.

Australian equities have fallen around 2 per cent, and international equities also fell by 1.8 per cent. Partly as a result, the overall equity portfolio has declined by nearly $20,000. This leaves the equity portfolio at around 89 per cent of the amount targeted in the plan.

Amidst some evidence of rising long-term bond rates, the value of gold holdings also fell by 3.3 per cent.

Finally, adding to the negative picture, the value of fixed interest holdings in the Vanguard Diversified Bonds fund fell by 1.3 per cent. Consequently they are now at their lowest dollar level since the last major investments in that fund were made in 2014.

The decline in portfolio value is the third largest in the history of the record.

Yet it follows a substantial phase of growth over the past year, in fact the strongest period of portfolio expansion in the entire journey.

Part of the reason for this is the unusually sustained growth in the value of equities over the past year. In these circumstances, a reversal over a single month appears less than consequential.

Following the closer examination of my superannuation holdings earlier this month, I contacted my superannuation fund to gauge their openness to a reduction in management fees, laying out some of the lower cost alternatives that I am considering. The surprising brisk reply was that the fund faced legislative restrictions in lowering their fees on my account.

To emphasise the point, they helpfully provided instructions and links to forms to move my superannuation elsewhere. It is an offer I shall be taking up, with my first preference being to move to the yet to be (re)launched Vanguard Super product within the next year.

Targeting the longer-term asset allocation goal of an equal balance between global and Australian shares, this month new investments were split evenly between the Vanguard global shares (VGS) and Australian equities (VAS) exchange funds.

Third quarter distributions rise above expectations

This month has involved finalisation of September-quarter portfolio distributions, allowing additional investments over the weeks ahead when these are paid out in mid-October.

The initial indicative distributions guidance from the exchange-traded funds (VAS, VGS an A200) points to a positive result for third quarter distributions. From previous average distributions I had expected a total of around $5,900.

Instead, from the yet to be finalised payments from the ETFs (and excluding any lumpy Vanguard diversified bonds payments), it appears third-quarter distributions could reach $10,100.

This compares to around $3,500 for those funds in the same quarter last year. The higher payout per unit this quarter is likely a function of higher resources and export prices over the period, and some continued relinquishing of precautionary cash reserves on firms balance sheets.

Tacking upwind – a rebalancing challenge on the homeward leg

One of the reasons for starting this record was to discuss the ‘second half’ of the financial journey.

When the record began, total assets were at approximately 40 per cent of the final portfolio target. Since early 2017 the overall portfolio target has been closed on, recalibrated and extended, and finally met.

The sub-target of reaching $1.9 million in equities remains unmet, however. Further, the balance between Australian and global equities is not yet at my longer-term target allocation of 50/50.

One noticeable and growing challenge in the second half of the voyage is entirely of my own making: an increasing rebalancing task.

The reason for this is the changing nature of the portfolio through time, and a movement since 2018 away from investment products featuring automatic rebalancing, to asset specific exchange traded funds, such as VAS, VGS and A200.

Over time, this has meant a diminishing role in the portfolio of funds featuring rebalancing. As an example, Vanguard’s High Growth diversified fund was around 60 per cent of the portfolio at the start of the record. Now, it has receded to about 30 per cent of the total portfolio value.

A further issue that arises by mathematical necessity at this stage of the journey is that even small percentages of the portfolio constitute larger absolute dollar values.

Two trends converge – the growing rebalancing task illustrated

The chart below illustrates the compounding impact of these two gradual processes, which are almost imperceptible on a monthly basis.

On the left axis the chart shows the gradual decline of the proportion of portfolio funds in investments which automatically rebalance to a set asset allocation (blue bars).

On the second right-hand axis, the red line provides an illustration of the total dollar value impact of a hypothetical one per cent change in the value of equities.

From this chart it can be seen that the automatically rebalanced component of the portfolio started at around 90 per cent, and fell gradually through to 70-80 per cent in the period 2010-2017.

The relatively small declines of this period were mainly the result of increased experimentation in investments outside of the Vanguard diversified funds, often into single asset investments (such as gold, Peer to Peer loans).

A second more rapid decline is evident from 65 per cent in mid-2018 to less than 40 per cent in July 2021.

This steeper second decline is due to the expansion of investments into the exchange-traded funds (consecutively, A200, VAS and then VGS) over this period, with these being the focus of new investments, and re-investments from distributions.

Up until the March quarter of 2020, the majority of assets were being quietly and automatically rebalanced.

Two other observations can be made on this data:

• Portfolio growth has been slowly adding to the challenge – on a path consistent with the overall growth in the equity portfolio, the absolute value of a 1 per cent shift ‘out of balance’ has been growing. Over time, this means that the portfolio is harder to keep on the intended ‘course’ of asset allocation.

• New difficulty thresholds for rebalancing were crossed from 2019 – the twin impacts of increasing portfolio size and lower amounts automatically rebalancing crossed significant thresholds through 2019, with any required one per cent rebalancing requiring $10,000 of investments, and auto-rebalanced assets falling to around 50 per cent of the portfolio.

Over time the significance of this issue will turn on whether there are major and sustained divergences in the values of Australian and international shares, and the level of future distributions available for use in rebalancing.

Both of these issues are veiled in the uncertainty of the future.

Trends in average distributions and expenses

This month average credit card expenses continued to decline.

In fact, lockdown is impacting current spending to such a degree that I am considering lowering the regular automatic payments going to the credit card account, to avoid the balance gradually being driven into an unspent positive value.

Average distributions continue to slightly increase each month, even as average credit card expenses continue to steadily fall.

As a result the blue line of distributions continues a mildly upward trajectory, to around $7200. By contrast, the credit card expenses (red) line continues to track downwards towards $4800.

The most recent results are illustrated in the chart below.

From the above it can be seen that the sizeable ‘gap’ which has opened up between average total distributions received and monthly credit card expenses – a gap of about $2,000 per month – remains.

Looking at the overall contribution to total expenses, the chart below shows that a cross-over between a three-year average of distributions and all expenses occurred across March-April of this year.

Since that time a further cushion – in terms of recent average distributions exceeding total expenses – of 15 per cent has been built.

Progress

Measure	Portfolio	All Assets
Portfolio objective – $2,585,000 (or $90,500 pa)	106.8%	137.5%
Total average expenses (2013-present) – $84,400 pa	114.5%	147.4%

Summary

Defying the impulses of the season, the portfolio has stopped its growth this month, and reversed for the first time in three months.

Yet, taking a larger view, this is not surprising, given the exceptional growth across asset classes over the past year.

Taking leave, even amidst lockdown, has better allowed a zooming out from day to day perspectives and events, and a reflection on broader trends of change.

The slowly increasing challenge of managing asset allocation is just one of those trends. Another is the longer-term pursuit of a more equal split of Australian and global equities.

Throughout the journey, the portfolio has undergone significant changes. Many of these have been changes of a nature that is difficult to distinguish in advance, even with a spreadsheet full of different metrics and measurements. This provides a caution to remain flexible and anticipate disruptions ahead.

With the recent re-emergence of some equity market volatility, in part from uncertainties about the likely pathways for real interest rates, and inflation, it can be useful to recall the dangers of attempts to market time, highlighted in this excellent piece by Nick Maggiulli.

This is all the more the case, given fundamental debates as to the real drivers of equity prices over time, such as posited in this piece – which approaches the issue from a conceptually simple supply and demand framework.

Similarly, debates at the highest monetary policy-making levels also continue to demonstrate that what is ‘known’ about core financial parameters impacting asset values, versus what is assumed, is contested.

Beyond these unresolved debates I have enjoyed Big ERN’s recent three-part appearance on a vodcast series on sequence of return issues and safe withdrawal rates. Outside of traditional financial independence topics, I have also closely followed this intriguing debate on the future of Bitcoin with well known critic and gold supporter Peter Schiff.

On recent walks I have also been exploring the occasional podcast series ‘Finance and History’, with recent episodes covering the history of interest rates, and experimentations by the Venetian republic with ‘helicopter money’ during the early renaissance period.

Finally, despite it robustly challenging my monopoly on nautical FI analogies, I have also been catching up on The Ship’s Ledger, a recently started Australian financial independence blog.

With the portfolio still for the moment sitting above the final goal, there is a sense in which I am looking out upon the sea from the relative safety of a harbour, or shore.

And as time moves forward, the progress and potential margin of safety compounds. Yet as everywhere, the exact timing of storms from the sea is unpredictable, and even dry land is sometimes no protection.