For it is right, Athenians, to use prior events as a guide about what will happen in the future

Andocides

This is my eighty-second monthly portfolio update. I complete this regular update to check progress against my goal.

Portfolio goal

My objective is to achieve and maintain a portfolio of at least $2,750,000 by 31 December 2024 or earlier. This should be capable of producing an annual income from total portfolio returns of about $94,800 (in 2023 dollars).

This portfolio objective is based on an assumed safe withdrawal rate of 3.45 per cent.

A secondary focus will be achieving the minimum equity target of $2,200,000.

Portfolio summary

Vanguard Lifestrategy High Growth Fund	$737,295
Vanguard Lifestrategy Growth Fund	$38,682
Vanguard Lifestrategy Balanced Fund	$70,163
Vanguard Diversified Bonds Fund	$85,371
Vanguard Australian Shares ETF (VAS)	$426,674
Vanguard International Shares ETF (VGS)	$587,719
Betashares Australia 200 ETF (A200)	$276,661
Telstra shares (TLS)	$2,052
Insurance Australia Group shares (IAG)	$7,196
NIB Holdings shares (NHF)	$8,916
Gold ETF (GOLD.ASX)	$129,907
Secured physical gold	$20,534
Bitcoin	$465,913
Raiz app (Aggressive portfolio)	$20,515
Spaceship Voyager app (Index portfolio)	$3,447
BrickX (P2P rental real estate)	$4,458
Total portfolio value	$2,885,503 (-$56,273)

Asset allocation

Australian shares	35.7%
Global shares	32.4%
Emerging market shares	1.4%
International small companies	1.8%
Total international shares	35.5%
Total shares	71.3% (-8.7%)
Total property securities	0.2% (+0.2%)
Australian bonds	2.2%
International bonds	5.0%
Total bonds	7.2% (+2.2%)
Gold	5.2%
Bitcoin	16.1%
Gold and alternatives	21.4% (+6.4%)

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

Comments

This month the portfolio declined in value by around $56,000 – falling 1.9 per cent.

The decline means the portfolio has fallen back to a level first seen at the end of 2021, and in March last year.

The losses were widely dispersed across the different asset classes held. The equity portfolio fell as a whole, with global equities contracting by 4.0 per cent, and Australian equities falling by 2.8 per cent.

Gold holdings fell in value by 3.7 per cent. Bitcoin was comparatively stable across the month, losing just 0.6 per cent.

Increases in interest rates and a higher expectation of average rates over time also impacted negatively on bond holdings. These fell 2.0 per cent, to their lowest level in nearly a year.

New investments through the month were made to continue to target an equal allocation between Australian and global equities as set out in the plan. This led to a split through the month between Vanguard’s Australian shares ETF (VAS) and Vanguard’s Global Equities ETF (VGS).

My one other financial move this month was to recheck and comply with some required conditions for receiving a ‘bonus’ higher interest rate on my separate cash and emergency fund holdings.

From a long period in which this bonus rate was effectively hardly worth collecting, this is now producing a 5 per cent nominal return. Through a few simple moves to be eligible, a pre-tax annual return of around $3,675 or around $150 per month after-tax has been secured.

In an environment of 5-6 per cent inflation, however, it should be remembered that what in substance is being achieved is actually just an avoidance or mitigation of purchasing power erosion, rather than the creation of a new income stream.

A further investment interest this month has been reading about Plenti’s new Notes Market, accessible only to qualified investors who fall within a specific ‘target market’ determination.

These involve significant risk of capital loss as they are the most junior rated notes on cashflows from a range of personal loans, and so should not form a core part of anyone’s asset holdings. The Notes are effectively offering exposure to higher risk Asset Backed Security market instruments, normally not available to retailer investors. I am considering a small ‘exploratory’ investment in these next month.

Guiding by the stars: reviewing taxation data on portfolio performance

This month saw the finalisation and submission of my tax return for the financial year of 2022-23.

Completion of this task adds to the set of independently verified data on progress toward the financial independence goal, as well as providing the opportunity to see trends and developments in the shape of the journey.

This year has seen a decrease in a key measure of ‘pre-tax’ portfolio income.

This measure counts income from partnerships and trusts, interest and dividends. It also including the full value of franking credits distributed. Capital gains are excluded.

In this way, it is somewhat comparable to a notional pre-tax salary figure, as is discussed further below.

What can be seen from the chart is that this measure of portfolio income fell by around $10,000, or 11 per cent compared to last year.

Even so, this is still the second highest level of income received by this metric, and around double the level received only 5 year ago.

By which stars? Selecting the right income measure

The reported income in the chart above is, however, not the only possible measure of reported income that could be used.

From the tax data, a least three measures could be plausibly argued to be consistent with a broad view of the wealth generating potential of the portfolio.

First, it is possible to consider only investment income as reported, while excluding franking credits. This would be a narrow conception of only distributed income, ignoring that in most cases a dollar of franking credits offsets a dollar of tax that would otherwise be paid, and thus, in some ways, is equivalent to a dollar of pre-tax income.

A second possible approach is recognising this fact, and adding into the total the value of franking credits.

Finally, it is possible to consider the reported taxable investment income (interest, dividends and income from trusts and partnerships), add in the value of franking credits, and additionally consider the reported net capital gains.

Over the past seven years, as the financial independence portfolio has grown in size, the difference in applying each of these approaches has grown

The chart below sets out the results of using each approach over the past 17 years.

If considering portfolio income as an alternative to salaried employment, it appears most accurate to focus on the second approach.

This takes into account the value of franking credits in avoiding the equivalent amount of tax liability, making the second approach most comparable to a ‘pre-tax salary’ amount.

Using the third approach risks over-estimation, as the realisation of capital gains can be a function of rebalancing within a fund or other transactions that do not relate to the ongoing capacity of the assets to sustain a particular income level over time.

Reviewing the components of portfolio income

For a more detailed view of the preferred measure, the chart below sets out the different reported components of the portfolio income.

Looking below the surface of the overall levels a few points are evident:

• Foreign income is at the highest level ever, at over $16,000 last year, reflecting the expansion of global shares holdings over the past two years

• Franking credits have moved to make a reliable and significant contribution to total investment income, approaching constituting around 20 per cent of income

• Income from partnerships and trusts – which include the managed and exchange traded funds dominate as these increasing make up nearly all of the portfolio

Relationship between investment income and the portfolio level

The additional data also allows for the tracking of the relationship between the taxable investment income received and average levels of the financial portfolio (e.g. the portfolio excluding Bitcoin).

This continues to show a relatively tight connection, albeit slightly diverging across the immediate impact and aftermath of market instability from 2020-21.

Stepping back: reviewing the trends

As a final alternative view of trends in taxable income the chart below sets out one of the broader measures of returns from the portfolio.

This aggregates net capital gains, franking credits and the reported investment income. In effect, this can be thought of as the ‘total financial benefit’ produced by the portfolio in a year.

As discussed above, this cannot be considered a equivalent to a pre-tax income, as the inclusion of net capital gains at least creates the potential for this to overstate the total sustainable returns that might be accessible over the medium term.

This chart shows the variabiity in the level of both net capital gains, and franking credits on an annual basis, but highlights a generally sustained step change from 2020-21 onwards, even if the last year has seen a decline in overall ‘financial benefit’.

Projecting third quarter distributions: a series changing in shape

At the end of September third quarter distributions will be finalised, to be paid across early to mid October.

These are usually smaller than the June and December quarter payments, due to the timing of payouts from funds, and the cycle of most dividend payments.

Distributions generally through 2023 have been well down on previous years, but from provisional distribution estimates from the ETF (A200, VGS, VAS) providers, this appears to have reversed in the current quarter.

The prior central estimate was for third quarter ETF distributions to reach around $10,000, or around the same level as in 2021. Set against this, the projections over the past two years for this quarter – using average distributions payouts – had typically under-estimated the level of actual ETF distributions by between $3,000-4,000.

That, it turns out, is exactly what has transpired. The estimates of the A200, VGS, and VAS funds suggest a final set of ETF distributions of around $14,000. This estimate, together with the estimated Vanguard distributions and actual results from past years is set out below.

Third quarter distributions have shown consistently strong growth for the past five years.

When the distributions are paid in mid-October, 75 per cent of them will be invested in Australian or global shares ETFs, with the allocation being driven by the goal of an equal split.

Trends in average distributions and expenses

Last month I revised estimates of my regular fixed costs, which are then used as an input into the total annual expenses estimates set out below. Inflation, as well as increased fixed and credit card expenses have led to a total increase of arround $10,000 in estimated annual expenses compared to early 2022.

This has contributed to a much lower gap between distributions and total expenses, based on these new estimates and trends in expenses.

The chart above measures distributions against this newly revised estimate of total expenses. The total expenses figure is based on actual credit card spending, with the addition of the mentioned monthly allowance for fixed expenses.

As can be seen, average total expenses (red line) continued to rise from a new higher re-estimated base, reaching above $7,100, while the moving average of distributions (the blue line) continues to decline through 2023, to around $8,200.

The total ‘gap’ between distributions and total expenses is now around $1,100 per month, compared to around $2,000 per month in early 2023.

Progress

Measure	Portfolio	All Assets
Portfolio objective – $2,750,000 (or $94,800 pa)	105%	136%
Total average expenses (2013-present) – $87,700 pa	114%	148%
Target equity holding in portfolio – $2,200,000	94%	N/A

Summary

Reviewing an investment portfolio structure as part of work this month provided a reinforcement of the difficulty of the task of investment management in these past two years.

The potential closing stretches of this journey are being made as large currents cut across the intended course. Worse, some storms threaten.

In some ways, some elements of a superficial normalcy are returning in markets, with interest rates returning to levels seen in the past. Yet in real terms, rates remain close to zero, and elements of continuity with the post-GFC environment are sustained.

One of the cross currents that could have a multi-decade impact is the gradual emergence of ‘financial repression’ across developed country asset markets. Which is just to say, conditions similar to the post-war phase of 1945-78 in many developed economies where high war debt burdens were gradually reduced. This featured higher inflation, and interest rates often suppressed to below headline inflation.

This kind of ‘regime change’ in markets is potentially problematic for anyone heavily reliant on ‘rules’ or ‘rules of thumb’ drawn from a different regime. There are risks in a strategy which is ‘overfit’ to a backward-looking set of financial market conditions.

It might be asked, however: if the future is beyond our control, what is the value of dwelling on it?

History can highlight possible directions for the future that are different from just an extrapolation of current relatively smooth conditions. This fact is both a reason to continue to consider history, and a warning that ‘it will all turn out fine, because it has mostly to date’ is an inadequate risk-management approach for a decision with some ‘one-shot’ – or partly irreversible – characteristics.

Noticing that a regime might change is not enough, action is at some point required. At the moment, I have not passed the threshold for any specific action. Most would seem to involve positing sectoral or geographic ‘winners’. These judgements, however, are often wrong in conception, execution, or priced into the relevant markets already, or negated by other as yet unknown factors.

My primary response now is to be aware of, and seek out different perspectives which challenge comfortable consensus views around current asset markets. The diversification of global equities provides at least some starting point for limiting impacts – however, this does remain exposed on a capitalisation weighted basis to all developed world economies.

An interesting conundrum is that prospectively speaking, the nominal yields on new bond holdings are clearly higher than they have been for some time. Yet the threat of measures of financial repression, and their particular impact on fixed interest investments, cannot be ignored.

Investment commentator Russell Napier provides some further interesting views on these topics here. In addtion, I have enjoyed listening to the podcast Hidden Forces and Napier’s Library of Mistakes interviews over the past few weeks.

Each of these episodes focused heavily on history. And it is a matter of history, that should not be forgotten that even the Athenian empire, itself, passed into oblivion, in spite of a flowering of historical study within its centre. A reminder perhaps that history – like markets – provide no guarantees except surprises.

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.