Do nothing for money

Periander of Corinth, Diogenes Laertius, Bk I.97

Twice a year I prepare a summary of total income from my portfolio. This is my eleventh portfolio income update since starting this record. As part of the transparency and accountability of this journey, I regularly report this income.

My primary goal is to maintain a portfolio of at least $2,620,000 which is capable of providing a passive income of around $91,600 (in 2022 dollars).

Portfolio income summary

Investment	Amount
Vanguard Lifestrategy High Growth (retail fund)	$10,390
Vanguard Lifestrategy Growth (retail fund)	$489
Vanguard Lifestrategy Balanced (retail fund)	$756
Vanguard Diversified Bonds (retail fund)	$453
Vanguard Australian Shares ETF (VAS)	$8,199
Vanguard International Shares ETF (VGS)	$1,939
Betashares Australia 200 ETF (A200)	$5,787
Telstra shares (TLS.ASX)	$43
Insurance Australia Group shares (IAG.ASX)	$165
NIB Holding shares (NHF.ASX)	$168
Plenti/Ratesetter (P2P lending)	$59
Raiz app (Aggressive portfolio)	$191
Spaceship Voyager app (Index portfolio)	$0
BrickX (P2P rental real estate)	$42
Total Portfolio Income – Half-Year to December 31, 2021	$28,680

The chart below sets out the income or distributions received on a half-yearly basis from the financial independence portfolio over the past five and a half years.

The following pie chart is a breakdown of the percentage contribution of each major current investment in the portfolio to the total half-yearly distributions.

Comments

Total distributions in the half-year to December 2021 from the portfolio were $28,680 – or the equivalent of around $4,780 per month over the past six months.

This outcome is lower than the equivalent period in 2020, but well above the equivalent periods in the prior two years.

The level of distributions fell reasonably close to some projections that were based on past average distribution rates for the Vanguard retail funds and exchange traded funds.

Using this approach, for example, expected portfolio distributions were around $28,000. This increases my confidence in this estimation approach, even while outlier results remain distinctly possible.

December half-year distributions have consistently been smaller than those released at the end of June. They generally represent around 40 per cent of total annual distributions, principally due to the specific pattern of payouts from the Vanguard retail funds.

This trend has weakened over the past several years, with the gradual accumulation of the three main exchange-traded funds (A200, VAS, VGS) which pay out on a slightly more even quarterly basis through the year.

Tracing the curve: trends in portfolio income from 2000 to 2021

The closing off of the calendar year allows some updated longer-term comparisons across the journey to financial independence so far.

This calendar year just passed distributions totalled $121,451 or around $10,100 per month.

This is the highest total for calendar year distributions on the journey so far, and over 35 per cent higher than the previous high last year.

The chart below gives a history of total portfolio distributions in nominal dollars, with green bars indicating the period covered since the start of this written record.

The red dotted line tracks the average level of the portfolio across each year.

There is twenty-two years of data in the above chart reflecting a long-term journey from the early years of my professional career until now.

The types of investments and market conditions have changed substantially.

At its commencement an ING Direct cash account (earning around 4.25 per cent), some Telstra shares and a murderously high-fee actively managed fund from Colonial First State constituted the entire portfolio.

In those early years of the journey, portfolio income made up a tiny percentage of total income. For example, it took the progress of five years for the portfolio distributions to even reach 5 per cent of my total income.

Yet as the shape of distributions in the chart above shows, there is a powerful force of compounding playing out as the journey continues.

Importantly, and also reflecting forces of compounding, the shape of the incline in distributions also reflects growth in the overall level of the portfolio itself, with slow progress at first, and then substantial gains in later years.

The growth in portfolio income over time is actually quite close to an exponential function, almost perfectly matching the red dotted line of the average portfolio level across most of the journey (an R_² value of above 0.9).

More than half of all distribution income has been received in the last four calendar years (green) of this blog. Close to two-thirds of all distribution income has occurred in the past five years.

It is worth noting that for simplicity the graph above tracks nominal dollars and so mildly overstates the ‘real’ value of recent distributions and portfolio values compared to distributions earlier on the journey.

This has the effect of slightly exaggerating the relative significance of recent progress compared to earlier years, but does not change the essential dynamic. For example, even using real constant dollars ($2020) the first 8 years of portfolio income generated less than 10 per cent of all distributions received to date.

In mid-2020 I theorised that the previous four years might have established a new ‘normal operating range’ for portfolio distributions, with most observations falling within the range of $50,000 to $70,000. This half-year result seems to confirm that this phase shift has occurred, albeit sometimes punctuated by anomalously higher results.

It is difficult to speculate on possible directions from here. Operating profits remain strong across many businesses, but some challenges lay ahead. Overall, long-term averages are likely to be the best indication going forward.

Manifest change: assessing the shifting composition of the portfolio distributions

The shape and makeup of distributions continue to shift over time. Since June 2018, all major investments have been made exclusively in three exchange-traded funds – A200, VAS and, more recently, VGS.

Typically, half-year to December distributions feature a lower contribution from the Vanguard Diversified High Growth fund which is usually a largest single component of portfolio distributions each year.

The chart below sets out the different level and components of half-year to December period over the last five years.

This highlights the growing role of exchange-traded fund distributions mentioned.

It is also notable from this chart that the high overall results in both the 2017 and 2020 December half-year periods were probably anomalies, rather than harbingers of things to come.

By contrast, in the chart above the progression of ETF-based distributions appears relatively steady across the period from 2018.

On a longer time-scale this pattern can also be be seen in this chart below, which sets out the level of, and changes in, major components of portfolio distributions over the past two decades.

From both charts it can be seen that this particular half-year the distributions from the Vanguard High Growth fund (teal) have fallen to levels comparable to the same periods in 2016, 2018, and 2019. This is suggestive that outcomes in December 2017 and 2020 were outlier events.

At the right-hand side of the chart above signs of the growth of distributions from the three ETFs are increasingly visible.

From June 2018 onwards the distributions from the VAS (purple) and A200 (blue) and more recently VGS (grey), exchange-traded funds start to slowly creep upwards.

Partly as a result, Vanguard retail funds have made up less than 40 per cent of total half-year distributions.

The Vanguard funds tend to also have more variable payouts over time due to rebalancing and investor redemption activities combined with associated realisations of capital gains within the Vanguard retail funds.

For a point of comparison around the make up of these half-year results, and a broader annualised picture, the composition of the full 2021 calendar year distributions is set out in the pie chart below.

The changes in the shape of the portfolio are in evidence here as well. In 2020, the three exchange-traded funds distributions made up just 13 per cent of the total year distributions. This past year, they represented 32 per cent.

Comparing the average rate of portfolio distributions

The overall portfolio distribution rate for this calendar year is 4.5 per cent.

This rate is estimated as annual paid out cash distributions as a simple percentage of the average total portfolio value over the year.

As a measure it allows for a different view of the annual income performance of the portfolio – one which accounts for the growing size of the portfolio.

Despite the high distributions received in the half-year to June, the overall distribution rate of 4.5 per cent for this calendar year just passed is actually just below the average over the period.

At 4.5 per cent it is, in fact, exactly equal to the median value of the past twenty years.

Above the water line: portfolio distributions and expenses

A typical measure for whether financial independence has been fully achieved is the level of portfolio investment income compared to normal expenses.

The chart below sets out the proportion of estimated total expenses (recorded credit card expenses plus estimated additional annual fixed expenses) that have been met by portfolio distributions through time.

To reduce the volatility of month-to-month results, rolling three-year averages of both distributions and expenses are used in the chart.

This shows that since the beginning of this record average distributions have gone from meeting around one-third of total annual expenses to crossing the 100 per cent threshold in April 2021. Currently the measure sits above that, at around 120 per cent.

The crossover point – as the brilliant book Your Money or Your Life would term it – resulted from both a continued trend fall in expenses, and increased distributions over time.

A similar story – albeit at smaller scale – is told in the tracing of progress towards distributions meeting my past ‘credit card FI’ goal. This is shown in the following chart.

This takes a three-year moving average of both distributions and credit card expenses up to the end of December.

This chart has been recalculated since last month using the latest distributions data, replacing previous placeholder average estimates.

It can be seen that a ‘crossing’ event (distributions exceeding average credit card bills) has clearly occurred by July 2020 as credit card expenses continued to trend lower, while distributions gradually climbed past them.

The still hard to adjust to the fact is that distributions of the financial independence portfolio now more than pay for every single item typically bought on my credit card in day-to-day life.

Reducing the ballast: using the portfolio distributions

Based on distributions announcements, the December distributions from the Vanguard funds, and exchange traded funds A200, VAS and VGS, should mean around $17,300 of capital is available to be invested or used over the next few weeks.

This sum is less than the full half-year total reported above because September quarter distributions from a number of the funds and ETFs have already been paid and were immediately re-invested in October.

Based on my updated rule I will put aside 30 per cent of the payments (around $5,000) to meet future portfolio-related tax liabilities.

My current plan is to reinvest the remaining $12,000 in equal increments on a monthly basis though January to July.

These increments will be directed according to my recently reviewed asset allocation plan, generally targeting slightly greater contributions to whichever asset class is furthest from its percentage target allocation in each particular month.

In the recent annual review I took the decision to target a higher equity portfolio allocation of 80 per cent, and to continue to seek over the medium-term an equal equity exposure to global and Australian shares.

Given this, it is likely to mean future investments will be directed to both the Vanguard international shares ETF (VGS) and its Australian equity-focused equivalent (VAS). The relative required magnitudes of these investments will depend on future market movements in these markets, taking into account the long-term nature of the target.

Refitting and reviewing the emergency fund

A regular task following finalising each half-year distributions estimate is to review the required level of my emergency fund.

This fund is currently set at a level of providing the equivalent of one year of expenses equal to my Portfolio Goal target income of $91,600. It is primarily designed to cover expenses in any unexpected periods without employment income or to help meet any major unanticipated expenses.

I determine how much cash is required for the emergency fund by reference to the gap between an estimate of average distributions and the target income.

The December half-year distributions takes the raw five-year average of annual distributions to just over $82,000. I have also reviewed alternate estimates based on average per fund or ETF unit distributions and long-term estimates of total distributions as a percentage of the portfolio.

These two approaches suggested likely forward distributions of $68,000 and $71,000 per year respectively.

An average of all of these approaches suggests likely future distributions of around $74,000 per year that could be drawn upon.

In recognition of this I will be marginally reducing my emergency fund from $21,000 to $18,000.

At present I am intending to re-invest this surplus $3,000 into the portfolio.

This is with a view to using future cash distributions paid closer any transition to different work arrangements or early retirement to complete the building of a separate targeted 12 months of cash reserves designed to smooth out or avoid portfolio withdrawals in adverse periods.

Observations

The December half-year distributions were largely within the range of forecasts and expectations.

When distributions in the first half of the year – which were around double that ever achieved before – are added, however, this means calendar year 2021 has produced decidedly strong flows of portfolio income.

Despite the anticipated economic impacts of corona virus and further lockdowns, across the past two years the absolute effects on dividends and distributions as a whole have been quite benign. Indeed, the most evident effect at present is lower average dividend yields for the market, due to increased valuation levels of Australian shares.

For example, the current Australian market dividend yield at purchase is around 2.9 per cent, lower than the average historical figure of around 4 per cent. Only time will reveal whether the traditionally higher Australian equity yield levels re-emerge, or if they move permanently closer to those lower dividend yields which are common across many international developed markets.

Regardless of this, the distributions this half-year reaffirm that income from the portfolio has now moved well beyond the past measure of paying all regular credit card expenses. In recent years it has instead moved to the position of comfortably meeting average total expenditure.

In December 2019 I observed that the income from the portfolio notionally represented another additional full-time worker, effectively earning capital each day on my behalf, at above the median wage.

That notional worker was earning $29.31 per standard working hour in 2019. By contrast, over the past twelve months, they have earned $61.46 per hour.

Over just this past year alone this tireless portfolio ‘worker’ has effectively received the equivalent of a 37 per cent pay rise over their 2020 salary – though in part this is likely a temporary ‘bump’ arising from higher than normal June distributions.

Or to consider the same essential point expressed in another way, every single hour of every single day and night last year the investment portfolio has relentlessly worked away, to earn the equivalent of around $13.86 per hour.

What is remarkable and mostly unforeseen in terms of the earlier part of the journey is that this steady income stream is reinforcing itself in many subtle ways each day, and slowly expanding into a widening river.

It is silently refilling my pocket even as I spend. It is slowly freeing up capital previously dammed up within a higher required emergency fund – further pushing forward progress. And finally, it is steadily building a pool of unquantifiable hope and optimism for a tomorrow that is significantly freer than today.

With this sustaining flow of passive income continuing, attention can further turn to what the shape of life could look like in 2023. It promises a capacity to reflect, at leisure, without the need for a carefully financially calibrated limit or finite end-point by which a conclusion on ‘next’ must be reached.

Above all, as the distributions begin to appear in coming days, it provides at once a strange reality to, as well as an inversion and proof of, the dictator Periander’s instruction to ‘do nothing for money’.

Explanatory Notes

Income distributions reported above do not include associated franking credits. My current preference is to seek to track cash actually delivered to my bank account as a tangible and easy to calculate measure. Last financial year franking credits valued at around $7,433 were received from all shares, ETFs and Vanguard retail funds, bringing the total distributions on a notional ‘pre-tax’ basis to approximately $36,300.

The income assumed for funds in the Plenti peer-to-peer lending platform is based on historical averages of the applicable lending rates used, together with the average balance over the periods. For analytical simplicity some composition graphs exclude small income from smaller holdings such as IAG, NHF and Telstra, as well as Raiz, Spaceship and Plenti. The total income excluded by this approach ($668) constitutes just 2.3 per cent of the total income received.