Things do not change; we change.

Henry David Thoreau

Twice a year I prepare a summary of total income from my financial independence portfolio. This is my thirteenth 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 $2,750,000 which is capable of providing a passive income of around $94,800 (in 2023 dollars).

Portfolio income summary

Investment	Amount
Vanguard Lifestrategy High Growth (retail fund)	$9,782
Vanguard Lifestrategy Growth (retail fund)	$438
Vanguard Lifestrategy Balanced (retail fund)	$551
Vanguard Diversified Bonds (retail fund)	$98
Vanguard Australian Shares ETF (VAS)	$9,059
Vanguard International Shares ETF (VGS)	$2,901
Betashares Australia 200 ETF (A200)	$6,890
Telstra shares (TLS.ASX)	$45
Insurance Australia Group shares (IAG.ASX)	$63
NIB Holding shares (NHF.ASX)	$132
Plenti/Ratesetter (P2P lending)	$0
Raiz app (Aggressive portfolio)	$192
Spaceship Voyager app (Index portfolio)	$0
BrickX (P2P rental real estate)	$20
Total Portfolio Income – Half-Year to December 31, 2022	$30,171

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

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

Comments

Total distributions in the half-year to 31 December 2022 from the portfolio have been $30,171 – equivalent to around $5,000 per month over the past six months.

The result is quite close to the same period last year, but below the unusually high distribution payouts of the second half of 2020. It is the third highest December half-year distribution on record.

The actual level of half-year distributions fell around 17 per cent below the forecasts made in my November portfolio update. Those estimates were based on past average distribution rates per unit for the Vanguard retail funds and exchange traded funds.

The major reason for the short-fall appears to be a reversion to longer-term averages in distributions of the Vanguard High Growth retail fund, with the results being closer to these longer term averages than average payouts across just the past five years. Outside of this fund distribution prediction, the earlier projected distributions were workably accurate, taken as a whole.

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 lumpy pattern of payouts from the Vanguard retail funds.

This trend has slightly 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.

This more recent pattern of a ‘flattening out’ of the portfolio distributions within the year can be seen in the chart below, in particular through the growth from year to year in Quarters 1 (March) and 3 (September) in particular.

Long-term trends in portfolio income: 2000 to 2022

The end of the year allows for a fuller longer-term perspective on distributions to be provided, covering the entire financial independence journey to date.

This calendar year just passed distributions totalled $98,139 – or nearly around $8,200 per month.

The represents the second highest calendar year distributions on the entire journey, exceeded only by the unusually high 2021 distributions.

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, which underwent relatively rare fall over last year.

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

Over that time, the types of investments and market conditions have changed substantially.

Within each of these bars is a evolving mixture of funds and fixed interest investments, across a variety of markets and conditions.

The two elements that are quite apparent from the chart is the role of compounding in the journey, and the close connection between the absolute level of the portfolio and the level of distributions.

To illustrate the first, nearly half of all distributions ever received occurred in the past four years. Around three-quarters, or 75 per cent, of distributions have accrued in the past seven years, since 2016.

There are substantial variances at times between the level of distributions and the portfolio level.

Some of these are caused by periods of higher valuations of non-income producting assets, such as Bitcoin or gold. Others likely arise from the shifting level of interest rates, and changing allocations over time between income and growth focused assets.

As in previous reports, it should be noted 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.

The impact of this is to slightly exaggerate the relative apparent significance of recent progress compared to earlier years, but it does not change the essential conclusions.

The past couple of years have been unusual ones in terms of payouts. In early 2020, many large firms – including banks – held dividends back as a precautionary measure, which shifted then to higher than average payouts as the economic picture became clearer in 2021. This has distorted the timing of distributions across 2020 to 2021 .

This makes it necessary to discount recent yearly variations as having significance for long-term trends.

Looking back over the past five years, the median average annual distribution has been around $80,000 while the mean average has been around $85,000.

The evolving composition of portfolio distributions: from 2017-2022

The composition of the portfolio distributions received over the past six years of the journey continues to evolve.

The starkest trend is the reduction in the relative significance of the Vanguard retail funds distributions within the total set of distributions. This occurs due to a refocus of investments since 2018 into three exchange-traded funds – A200, VAS and, more recently, VGS.

In the half-year to December, only a third of total distributions came from the largest Vanguard fund, where once this fund essentially defined the level of overall portfolio income.

The chart below shows this evolution in progress. It sets out the different level and components of half-year to end December period over the last six years.

Aside from a couple of anomalous years, the distributions from the exchange traded funds grow until eventually – collectively – they outweigh the significance of the Vanguard retail funds.

The same broad trend is found when full calendar year data is compared, as in the chart below.

From around 2019 the exchange traded funds appear as significant contributors to overall distributions.

International shares typically have lower dividends than Australian equities, meaning that distributions from the Vanguard Global Shares ETF have not grown as strongly over recent years as those from Australian share ETFs, even as investments have heavily tilted in that direction to reach the target asset allocation.

While there can be sound reasons to employ a few different investment vehicles, it is important to remember that there is nothing inherently market risk-reducing about a diversity in those vehicles.

The underlying assets owned and their performance determine the shape and level of portfolio distributions – and similar or in some many cases identical assets are underlying the Vanguard High Growth fund and the three ETFs owned.

Mere diversity in specific investment vehicles, while sometimes desirable for other reasons, cannot act to change the underlying performance characteristics of the assets held.

For a comparison to the structure the half-year results above, and a broader picture, the composition of the full 2022 calendar year distributions is set out in the pie chart below.

The evolution in the make-up of portfolio distributions is also quite clear from the chart above.

Across 2022 the exchange traded funds provided around 52 per cent cent of the total distributions, compared to a low of around 16 per cent in 2019, just three years earlier.

A longer-term perspective on the shifting composition of distributions: 2000-2022

A different perspective on the same processes, applied across a longer time period, is provided by the chart below.

This details the level of, and changes in, major components of portfolio distributions over the past two decades.

The dominating feature of this chart remains the high and variable distributions from the Vanguard High Growth fund (teal).

These often include a large element of paid out capital gains arising from fund rebalancing to meet allocation targets, or fund redemptions, neither of which are pure investment income generation.

For this fund, half-year payments tend to oscillate between lower December payments of around $9,000 to $10,000, and higher June payments in the $25,000 to $35,000 range. As no new contributions are being made to the fund, its distribution pattern and levels of payment are likely to be approximataly sustained or perhaps slightly decline through time.

Over the past three year distributions from the VAS (purple) and A200 (blue) and to a lesser extent VGS (grey), exchange-traded funds have generally advanced to become become significant in their own right.

As seen earlier, in the case of the Australian funds (VAS and A200), despite absolute falls this year from higher June payments, these on average are starting to emerge as regular sources of significant income.

Plotting a future course: estimating future portfolio distributions

Knowing where past distributions have been is one kind of knowledge about the future income generation potential of the portfolio.

Over time, I have built up an approach of forecasting future distributions, more out of interest rather than of necessity, to see whether broader long-run distributions could be estimated to any degree of approximation.

These projections have tended to focus on the shorter term, either the next three or six months.

The chart below sets out the first systematic projection of possible distributions for the full year ahead.

The general approach has been to rely on average past payouts, for the longest period of data available, while making a couple of specific judgement-based departures.

For the year ahead these departures included selecting bond income estimates below past averages, to recognise the remaining overhang of low rates on many bonds that effectively form part of the portfolio.

A second adjustment is using a five year averaging window for the estimated June quarter distributions from the Vanguard High Growth fund. Depending on whether payouts over the past five years, or a longer period turn out to be more representative, this could slightly upwardly bias the final estimate.

The chart below sets out the 2023 forecasts compared to past actual distributions on a quarterly basis.

Generally, this exercise shows that projected distributions for 2023 are expected to be around the same as that experienced in 2022, in the June and December quarters, but slightly lower than past distributions across the first and third quarters.

Collecting these estimates in one place will provide a transparent basis for assessing the methodology of forecasts through the year, and give a sense of whether progress matches earlier expectations.

Perspectives on the portfolio distributions: the view of passing hours

One of the most tangible and thought provoking perspectives on the progress in creating a portfolio income unconnected with any physical effort has been to view the portfolio itself as a silent, substitute ‘worker’, generating the income.

This metric has been noted irregularly in past posts and portfolio income updates. The charts below, however, provide the first systematic look at how the hisotry of portfolio income looks, calculated on an hourly basis.

The first and simplest way to view this metric is by considering the per hour ‘earnings’ of the portfolio, counting each and every hour of the year. The chart below sets out the level of per hour ‘earnings’ over the course of the journey.

The second way to view the same data is by considering the ‘earnings’ of the portfolio within only normal working hours.

This framing assumes that the portfolio only produces earnings in hours in which an ordinary worker would – so it equates to approximately the standard pre-tax hourly wage the portfolio is able to produce.

The chart, by mathematical necessity, is of course precisely the same shape, as all that is being changed is the denominator applied to the annual portfolio income, and so is not reproduced.

Over the past several years of the journey the effective per working hour earnings has averaged around $43 based on actual distributions, but with the same variability that is visible above. Over the last year, actual ‘per working hour’ earnings have been around $49.

Yet these ‘hourly’ earnings estimates can vary substantially according to the basis of calculations.

As an example of this, the chart below sets out the range of possible estimates, depending on precisely what ‘income’ is used as the numerator.

The different approaches here may be categorised broadly as using forward-looking estimates (based on median or mean past payouts), relying on taxable investment income data (including capital gains, or excluding it in the case of the lower ‘Taxable Income’ estimate). Finally, estimates based on 2022 actual distributions, and the previously discussed 2023 forecasts are given.

Depending on which estimate is used, therefore, each hour of 2023, the portfolio ‘worker’ might reasonably be expected to earn between $8 to $10, with some chance of slight under-performing or exceeding this by a small margin.

The flowing currents: using the portfolio distributions

Based on distributions announcements for the exchange traded funds A200, VAS and VGS and the December distributions from the Vanguard funds, there will be approximately $18,000 of capital available for use over the next two 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 when paid across October.

I intend to set aside around 25 per cent of these payments in cash to meet future Pay As You Go Instalment tax liabilities.

The remainder – around $13,000 – will be invested in equal increments on a fortnightly basis though January to June. These increments will continue to be directed according to my current asset allocation plan.

Given the ongoing goal to target, over the medium-term, an equal equity exposure to global and Australian shares, this is likely to mean future investments will be directed to the Vanguard international shares ETF (VGS) as international equity allocations continue to fall slightly below the Australian equity component.

A stable anchor: the emergency fund level held steady

Since 2017 a regular task following finalising each half-year distributions estimate has been 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 $94,800. It is 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 (i.e the emergency fund is set equal to the portfolio target income minus expected full year distributions).

For this estimate, I typically seek to average the raw five-year average of annual distributions, and alternate estimate based on average per fund or ETF unit distributions, and long-term estimates of total distributions as a percentage of the portfolio.

These three approaches combined indicate likely forward distributions of around $77,000 per year that could be used in an emergency. The emergency fund set last year was $18,000, and will be maintained at this level.

Observations

Over the past six years of this record the portfolio reports have been one of the most interesting to compile, as they can provide important clues on the changing nature of the journey.

Portfolio income is now of itself a significant factor in the growth of the portfolio, as well as in general life circumstances. Distributions, for example, began some years ago to easily outstrip any potential bonuses from full-time work, and form something like an average stand-alone salary.

While the level of portfolio distributions were studied closely early on, the portfolio income has now reached a level beyond which further growth may not be needed, or tax efficient.

Recent portfolio contributions over the past year have focused exclusively on global shares, which will not return significant regular dividend income, compared to Australian equities.

This investment focus means that the overall growth in the level of portfolio income seen over past years may be levelling off. In this environment results may be driven more by year-to-year volatility in earnings conditions and payouts, rather than just by growth in the size of the portfolio as previously.

An important caveat in thinking about the portfolio income totals reported, is that they represent a mixture of paid out capital gains and dividends and interest payments.

In particular, the Vanguard retail fund distributions include capital gains realised by rebalancing within the funds, and factors such as currency hedging gains or losses over time. The exchange traded funds typically have low turnover, limiting unnecessary capital gains, but these too form part of their distributions.

As an illustration, paid out capital gains across the portfolio has averaged around $44,000 per year over the past six financial years of the record.

This component of the overall portfolio income is not truly ‘passive income’, as the term is commonly understood. Rather, some part of it would need to be re-invested to maintain the overall value of the portfolio in real terms. Deeming it as wholly income that could be drawn on indefinitely would be decidedly risky.

In this way, the critical role of safe withdrawal rate used comes into focus, and makes slightly irrelevant the actual level of distributions that happen to arise in any single year.

When managing portfolio withdrawals using such a safe withdrawal rate, the actual level of income just becomes a number that affects what level of, or whether, actual withdrawals need to occur (or indeed whether some proportion of distributions need to be re-invested). That is, distributions almost become a type of error term to be managed.

Earlier in the journey, this type of circumstance would have appeared highly theoretical and remote.

The distance travelled has changed this. And, importantly, the change has been in part an attitudinal one, one internal to my own perceptions and thoughts, rather than flowing entirely from the world outside.

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 approximately $18,082 were received from all shares, ETFs and Vanguard retail funds, bringing the total half year distributions on a notional ‘pre-tax’ basis to approximately $39,200.

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 ($452) constitutes around two per cent of the total income received over the period.

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.