Investment for FI

These posts explore the analysis and approach that guide the journey to financial independent. They examine what what data and research shows about the optimum way to invest a long-term FI portfolio.

Portfolio Income Update – Half Year to June 30, 2019

Posted on by The FI Explorer

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Set your course by the stars, not by the lights of every passing ship.

Omar Bradley

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

My goals are to build up a portfolio providing for a passive income of around $67 000 by 31 December 2020 (Objective #1) and $83 000 by July 2023 (Objective #2).

Passive income summary

  • Vanguard Lifestrategy High Growth – $25 606
  • Vanguard Lifestrategy Growth – $1 626
  • Vanguard Lifestrategy Balanced – $1 630
  • Vanguard Diversified Bonds – $53
  • Vanguard ETF Australian Shares ETF (VAS) – $1 761
  • Betashares Australia 200 ETF (A200) – $4 513
  • Telstra shares – $43
  • Insurance Australia Group shares – $209
  • NIB shares – $120
  • Ratesetter (P2P lending) – $1 373
  • Raiz app (Aggressive portfolio) – $107
  • Spaceship Voyager app (Index portfolio) – $0
  • BrickX (P2P rental real estate) – $36

Total passive income in half year to June 30, 2019: $37 077

The chart below sets out the passive income received on a half-yearly basis from the portfolio over the past three years.HY Jun19 Series Income

The following figure is a breakdown of the percentage contribution of each investment type to the total half year income.

HY-Jun19 Pie

Comments

The total half year passive income from the portfolio was $37 077, the equivalent of $6 180 per month, and above my recent expectations. This was a significant rise from the previous half year to the end of December, consistent with the usual pattern of June distributions being higher.

This June half year result is, however, significantly lower than the equivalent 2017 and 2018 figures. It is now apparent that these previous two results were outliers, as they included significant payments arising from realisations of capital gains and the re-balancing activities of the Vanguard diversified retail funds.

Stepping back and examining distributions over the full financial year presents another longer-term perspective. Full year distributions have recovered from the poor start in the half to December 2018, and the full financial year results are $52 524, or just under $4 400 per month. This is fairly close to my recent estimates of the likely income potential of the portfolio at current levels.

In the chart below of the history of total portfolio distributions, green indicates periods covered by this record.Total dis FY Jun19

From this chart it is apparent that annual distributions have fallen significantly – around 20 to 30 per cent – compared to the past two financial years. Yet it is also clear that they have moved structurally above the years previous to this due to the continued growth in the size of the portfolio.

A year-on-year fall in annual distributions such as experienced this financial year is relatively rare – having not occurred since 2012 – but not unprecedented in the history of the portfolio. It has occurred on three other occasions over the past two decades. To date, a consecutive yearly decline has never happened.

Journey to credit card FI – a steadily closing gap? 

The full financial year data also makes it possible to recalculate comparative trends in distributions and monthly credit card costs as well as other expenses on a more representative basis than the previous unusually low December half-year income.

This chart below shows that from April 2019 and for the first time in about a year, credit card expenses have dipped temporarily below annual distributions.Credit card FI Jun19

This may not be sustained over time, as this series is naturally quite volatile. As expected, there is still a gap between estimated total expenses and distributions.

To provide a clearer picture of progress towards passive income meeting my ‘credit card FI’ goal, the following chart takes a three-year moving average of both distributions and credit card expenses.Closing gap 3 yr Jun19

This shows the gap continuing to close, to a remaining gap of less than $1 000 per month between credit card expenses and average distributions.

Changing composition of distributions and sources of variations

Over time the level of distributions will be affected by ongoing changes in portfolio composition.

The fall in the Ratesetter account balance and fixed income holdings overall will tend to reduce future distributions. Similarly, the large and growing investments in ETFs such as VAS and A200 will, at least in a relative sense, reduce the overall portfolio impact of the more volatile Vanguard fund distributions.

The reason for this can be seen in this new chart below, which tracks the major components of distributions through time.Dist by Type Jun19

This highlights the dominating influence of variations in the distribution payouts from the Vanguard High Growth Fund through time on overall distributions. It also shows that up until five years ago Ratesetter interest income represented one of the single largest components of distributions compared to just four per cent now.

The half year composition of distributions already given also reflects their cyclical payout pattern, with around 70 per cent being from the single largest Vanguard High Growth fund. Over time, the lower than average distributions from the Betashares A200 ETF – reflecting its market entry and rapid growth – should normalise, possibly representing a slight upward factor in its role in future distributions.

For a point of comparison against the half year result, the composition of the full financial year distributions is set out in the figure below. Comp FY dist Jun 19

From this it is apparent that collectively the distributions from the Vanguard High Growth fund, the A200 ETF and Vanguard’s VAS ETF decisively shape overall distributions currently, making up nearly 85 per cent of total payments.

The overall portfolio distribution rate (e.g. distributions as a percentage of the portfolio value) for this half year has been 3.5 per cent, one of the lowest rates recorded so far. This is likely due to falling fixed interest returns and the increased use of ETFs with lower payouts of capital gains than the Vanguard retail funds. The average (median) distribution rate over the past two decades remains steady at 4.4 per cent.

Av dist rate Jun19

Making course adjustments – putting distributions to work

The imminent payment of the July distributions from Vanguard funds, as well as the distributions from the Betashares A200 and VAS means that a total of around $30 000 will need to be reinvested or allocated in weeks ahead.

I will set aside around 25 per cent of this sum to meet the associated tax liabilities, and then expect to reinvest the remainder in even increments on a regular basis over the next six months. While market performance and history suggests a single lump sum investment would be financially optimal, my general practice is to use dollar cost averaging for large sums, to manage the risk of investing prior to a large market movement, and recognise the potential power of ‘decision regret’.

My current intention is to reinvest these distributions in Vanguard’s global shares ETF (VGS). This will be my first investment in this ETF, and flows from the fact that ‘the big rebalance’ to reach my intended 60/40 allocation split between Australian and international equities is now effectively complete.

Historically, I have been wary of this ETF’s high US equity market exposure, and its past returns have been strong (indicating the potential for a reversion to lower returns). However, I am seeking to follow my planned asset allocation, and have some expectation that any external events likely to reduce US and global returns will also likely impact on the Australian dollar, potentially partially offsetting some negative impacts. I am also attracted to the broad simple diversification it offers into areas not well covered by Australian equities.

A further step following from finalising the half year income estimate is to revise the level of my emergency fund. This is set at providing the equivalent of one year of expenses at a level equal to my Objective #2 target income – that is, $83 000. It has been primarily designed to cover expenses in any unexpected periods without employment income.

This most recent set of distributions takes the five-year average of distributions to just over $50 000. On that basis, I am reducing my emergency fund to $33 000, and using the additional capital this frees up as new contributions to the portfolio. Over time the growing average portfolio size should have the impact of tending to lower my emergency fund as the associated flow of distributions rises to replace it. Despite this, I always intend to keep a modest contingency cash allotment for liquidity and unanticipated cash requirements.

Observations

Around 251 years ago, Captain James Cook set sail for a journey across the entire Pacific Ocean to reach the island of Tahiti. His instructions were to witness and record the transit of Venus – that is, the journey of that planet against the disc of the Sun. Scientists and astronomers at that time hoped that by taking a range of measurements as the transit occurred, they might divine the distance between the Earth and Sun.

Similarly, this set of observations helps me understand some of the key measurements in my narrower universe – for example, my distance to a lifestyle funded by passive income, and the broad boundaries around the variability in that income that I might expect.

For much of the past six months, my curiosity about this particular result has been growing. While as a half year it is less spectacular than some past results, it feels like a firm foundation of what the portfolio might be expected to deliver on average over time. It also reasonably matches my previous analysis of the portfolio income potential.

On an annual basis, $52 000 of income represents a more than adequate level of basic financial security in my circumstances. The new figures also provide a cross-check on other measures of progress I use, reinforcing that I am now in a phase of consistently seeking to close the remaining gap between expenses and average total portfolio returns.

As global and domestic markets appear more ominous and finely poised, the relative stability of this income source compared to absolute capital values will also play a psychological role in allowing continued strong investments in equities ahead. Whether this be into storms or calms seas will soon enough be seen.

Explanatory Notes

  1. Income distributions reported do not include franking credits. My current preference is to seek to track cash actually delivered into my bank account as a tangible and easy to calculate measure. In this past half year franking credits valued at just under $2200 were received from shares and ETFs (not including the Vanguard retail funds). 
  2. There has been a small downward revision to the half year to December 31, 2018 income estimate of $15 602 to $15 447. This reflects the availability of better data from the annual tax statement, and substituting that data for projections made in December 2018. 

Monthly Portfolio Update – June 2019

Posted on by The FI Explorer
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I must go down to the seas again, to the lonely sea and the sky,
And all I ask is a tall ship and a star to steer her by;
And the wheel’s kick and the wind’s song and the white sail’s shaking,
And a grey mist on the sea’s face, and a grey dawn breaking.
John Masefield, Sea Fever

This is my thirty-first portfolio update. I complete this update monthly to check my progress against my goals.

Portfolio goals

My objectives are to reach a portfolio of:

  • $1 598 000 by 31 December 2020. This should produce a real income of about $67 000 (Objective #1) – Achieved
  • $1 980 000 by 31 July 2023, to produce a passive income equivalent to $83 000 (Objective #2)

Both of these are based on an expected average real return of 4.19%, or a nominal return of 7.19%, and are expressed in 2018 dollars.

Portfolio summary

  • Vanguard Lifestrategy High Growth Fund – $772 490
  • Vanguard Lifestrategy Growth Fund  – $44 487
  • Vanguard Lifestrategy Balanced Fund – $80 006
  • Vanguard Diversified Bonds Fund – $107 352
  • Vanguard Australian Shares ETF (VAS) – $88 322
  • Betashares Australia 200 ETF (A200) – $260 499
  • Telstra shares (TLS) – $2 052
  • Insurance Australia Group shares (IAG) – $14 405
  • NIB Holdings shares (NHF) – $9 204
  • Gold ETF (GOLD.ASX)  – $92 340
  • Secured physical gold – $14 807
  • Ratesetter (P2P lending) – $22 011
  • Bitcoin – $186 350
  • Raiz app (Aggressive portfolio) – $15 744
  • Spaceship Voyager app (Index portfolio) – $1 991
  • BrickX (P2P rental real estate) – $4 643

Total value: $1 716 703 (+$118 079)

Asset allocation

  • Australian shares – 40.2% (4.8% under)
  • Global shares – 21.5%
  • Emerging markets shares – 2.5%
  • International small companies – 3.2%
  • Total international shares – 27.2% (2.8% under)
  • Total shares – 67.4% (7.6% under)
  • Total property securities – 0.3% (0.3% over)
  • Australian bonds – 5.2%
  • International bonds – 10.0%
  • Total bonds – 15.2% (0.2% over)
  • Gold – 6.2%
  • Bitcoin – 10.9%
  • Gold and alternatives – 17.1% (7.1% over)

Presented visually, below is a high-level view of the current asset allocation of the portfolio.Pie - June 19

Comments

The portfolio has experienced the strongest growth on record through this month, with a total increase of $118 000. This pushes the portfolio well beyond Objective #1 to over $1.7 million.Monthly prog - Jun 19

This has followed a period of unprecedented growth in the absolute value of the portfolio, with an increase of almost $400 000 since January. A remarkable consequence of this is that over 20 per cent of the entire value of the portfolio has come into existence in this short six month period.

Month change 2 - Jun 19

This unbroken record instinctively invites expectations of a sharp – and possibly a quite sustained – reversal. I am determined, however, to act in accordance with my asset allocation decisions, not on the basis of overconfidence in my own capacity to predict or time markets.

The key contributors to growth this month have been continued appreciation in the price of Bitcoin, and even more significantly, increases in the value of Australian equities and gold. Lower official cash rates have strongly supported equity value growth, and a sharp increase in the price of gold has occurred. Combined, the gains in equities and gold accounted for over half of the total monthly increase.

New investments this month were focused on Australian equities. Following the lowering of the management fee of the Vanguard ETF VAS  – tracking the ASX300 index – to 0.10 per cent from 1 July, I also made my first new investment in VAS for eighteen months. This lowering leads to the VAS ETF becoming significantly more competitive in fees with the Betashares A200 (which charges 0.07 per cent). It also offers some (small) additional diversification benefit through tracking an additional 100 smaller listed companies.

Accounting for volatility and Bitcoin in asset allocation

The sharp increase Bitcoin’s value over the past month has brought the combination of alternatives (gold and Bitcoin) to just over 17 per cent of my portfolio, higher than sought. Bitcoin continues to serve a role providing portfolio diversification, but its recent increase has actually correlated with a rise in Australian equities. Recent price volatility leaves me conscious that the market value of these holdings could quite easily slip down to $50 000, its position a few short months ago.

If there is a star to steer by in such times, it is provided by the target asset allocation. Tracking back towards that in a time of intense volatility is the task at hand.

To ensure Bitcoin volatility is not unduly driving asset allocation decisions, however, I have started to test any new investment action I am considering taking on a ‘with’ and ‘without’ basis. This involves notionally backing Bitcoin completely out of the portfolio (or, more realistically, adopting a trailing average value) and assessing whether or not the asset allocation ‘signal’ for the direction of future investments changes.

The reason for doing this is to check that I am not undertaking hard to undo portfolio actions monthly merely as a response to Bitcoin’s unique price variations. At one extreme if I remove Bitcoin from allocation considerations (e.g. assume it has no value), I have actually already achieved my target equity allocation of 75 per cent. Taking a less extreme approach, however, of attributing just a lower trailing average value results in a continued signal to make new equity investments.

Waiting for the next set of distributions

This period prior to July distributions being finalised and paid always has a quality of uncertainty and contingency about it. Distributions have been quite volatile over time, principally due to different distribution levels from Vanguard retail funds. In turn, these are likely due to maintaining asset allocations, and irregular distributions of underlying capital gains.

My current July distribution estimates are for around $2600 from the Betashares A200 ETF, $800 from Vanguard’s VAS ETF, and around $16 000 to $23 000 from the Vanguard retail funds. These are based on median and average past distributions over the past 10 years for the funds and the already announced distributions in the case of the ETFs.

This could to mean that in early July I may have around $20 000 of newly available capital to re-invest in the market, however, these estimates are just that. In the past, distributions have at times been both dramatically less and more than anticipated. For example, the Vanguard High Growth fund has twice recently produced July distributions at levels above $30 000.

Following distributions being paid I will be looking to re-invest the capital in accordance with my target allocation. Two factors will likely drive these decisions. First, as discussed above the portfolio remains under its assigned equity allocation. Second, after a year of almost exclusive contributions to Australian equities, the target for that component is almost reached.

This means that a proportion of future contributions will be directed to international equities, to target the 60/40 per cent split I have set based on academic research on the historical record of the optimum balance of reducing volatility while maximising risk adjusted returns.

History of Australian equities research

This month the Reserve Bank of Australia issued a new research paper (pdf) on the history of Australian equities.

This draws on newly collected and analysed historical data on the past century of Australian share market returns, improving on previous incomplete or simplified data sets. Some of the key findings of this report have potential implications for my future portfolio planning. For example, the paper finds:

  • Dividend yields since the 1980s have averaged around 4.0 per cent, and prior to that have been 200 basis points lower than previously estimated
  • The historical geometric and arithmetic average equity risk premium (the equity return in excess of the 10 year bond rate) is between 4.0 and 5.2 per cent, lower than previous estimates
  • Australian and US equity returns are historically very similar
  • The overall composition of the Australian share market by sector is remarkably similar to a century ago
  • For several years leading up to 2018, the Australian equity market has tracked its historical valuation measures quite closely, with lower than historically average volatility

One implication of this is that in future investment policy reviews, I may need to lower my current estimate of long term real equity returns (currently 5.65 per cent).

Progress

Progress against the objectives, and the additional measures I have reached is set out below.

Measure Portfolio All Assets
Objective #1 – $1 598 000 (or $67 000 pa) 107.4% 144.5%
Objective #2 – $1 980 000 (or $83 000 pa) 86.7% 116.7%
Credit card purchases – $73 000 pa 98.6% 132.6%
Total expenses – $96 000pa 75.0% 100.9%

Summary

The rapid growth in the portfolio has been somewhat disorientating.

On an ‘All Assets’ basis, this has meant that all current expenses could theoretically be met from the portfolio and superannuation assets. Nonetheless, while this is pleasing, my focus remains on reaching my financial independence goals using just the portfolio assets.

The higher markets reach, the more interested I become in learning what I can from other periods of volatility. This has led to absorbing the book Wealth, War and Wisdom, a fascinating study of financial markets and returns through the convulsions of the twentieth century’s world wars and Cold War tensions. It examines the challenge of the protection of real wealth in extreme conditions, finding that a diversified portfolio of real and paper assets, including a large weighting to equities, generally performed well.

The Australian FIRE community has also been sinking its teeth into launches of the ‘Playing with FIRE’ documentary. For those not able to make one of the premieres, AussieFireBug’s most recent podcast provides a really enjoyable post-viewing conversation reflecting on its strengths and weaknesses. Also this month Big ERN has published an interesting guest post on safe withdrawal rates over 60 year periods. It makes the point that the ‘rule’ of 4 per cent can be risky and misleading over long time scales, with withdrawal rates of 3.5 per cent significantly decreasing the failure risk.

The passing of the winter solstice a week ago brings with it the promise of longer and lighter days ahead. The distributions to come also evoke a sense of a possible grey dawn breaking. In just a few days, the mists should lift and navigation of the portfolio towards my financial independence goals should be significantly clearer.

On Measurement – A History of Financial Benchmarks

Posted on by The FI Explorer
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If you have built castles in the air, your work need not be lost; that is where they should be. Now put the foundations under them.
Henry David Thoreau Walden

Essential to navigating any course is knowing your intended destination, and measuring one’s current position. Since the commencement of my journey to financial independence there has been a rather restless search for, and refinement of, the right measures to use.

Knowing just how far one is through a journey also helps to provide a sense of momentum. Key to measuring how much progress has been made is consciously thinking about and defining the end point.

This piece will look through the various benchmarks and measurements adopted, retained and discarded through the my journey, to share what I have learnt about measuring progress to financial independence, and set out the logic behind my current portfolio goals.

Early benchmarks – There lies the port (1999-2006)

There is a strong argument that the first FI benchmark I ever set was the most correct, and the rest have been excursions.

In September 2004, after around three years of consciously building up an investment portfolio, I read perhaps the most foundational financial independence work, Your Money or Your Life.

A central recommendation of this book is to physically graph out monthly income and expenses, from which naturally emerges a measure of the proportion of passive investment income to actual expenses. I did this from June 2003 until December 2005. Each week my calculations produced a simple percentage result of how close I was to the ‘crossover point’ – that is, the point at which passive income exceeds monthly expenditure and financial independence is achieved.

By the time I abandoned the monthly record I was, by my rough calculations, around 80 per cent of the way to the ‘cross over’ point. This was soon to fall, however, with the significant purchase of a house to live in with part of the portfolio, and a continuing fall in interest rates affecting some cash-based savings.

This same overall approach, however, underpinned my first ever explicit benchmark set for the portfolio in 2006. It was a quite logical and simple one: yearly investment returns should match my own average yearly expenditure.

Measures multiplied and buried (2007-2016)

As a measure this was hard to improve on, but this provided no deterrence. With the investment portfolio starting to grow after the house purchase I thought about what would be meaningful benchmarks again, and came up with a layered approach.

There were three new benchmarks under this approach, broadly themed as:

  • Comfort – This benchmark was investment income to achieve the median average national salary, with progress estimated as a percentage of current portfolio value against the total portfolio needed to deliver this at an assumed rate of return.
  • Independence – This measure was to achieve investment income equal to the median salary of a Federal public servant serving at a mid-range executive level. This was chosen because it represents a very comfortable standard of living and an average level of career achievement for a person with my qualifications.
  • Freedom – This measure was for investment income to be equal to the salary of a median public servant at a more senior level in a central government agency. This would enable a lifestyle that is untroubled by material need.

The logic behind this triple standard was a recognition that just reaching a comfortable level of investment income did not necessarily encompass all of my aims. Rather, I was curious to understand what might lay beyond, and what resources might give me a lifestyle indistinguishable from most of my peers in terms of ability to fully engage with the world’s opportunities, without requiring paid work.

The decision to measure progress by reference to an external benchmark was due to two factors. First, a benchmark that is externally linked to a particular standard of living helps ensure that the goal shifts broadly with changes in the broader community. Second, it made accounting for inflation easier, as the benchmark already accounted for its effects.

Years after these three benchmarks were set, I read about the six levels of financial independence, and it was apparent that as well as drawing on some similar concepts in Your Money or Your Life I had unconsciously replicated some of these. The six levels represent an excellent framework through which to think about the different stages of financial independence. Others, such as the ChooseFI podcast, have usefully added other milestones (i.e. ‘half-FI’) to supplement the approach, and place some way markers in between some of the larger steps.

The precise numerical expression of these three layered objectives shifted through time as I learnt more about realistic return expectations and updated them for the impacts inflation. In July 2007 I set a target portfolio value target of $750 000, with the explicit – though ultimately unrealistic – expectation of it producing around $50 000 in annual portfolio income. The goal of providing for a stream of passive income specifically targeting an average income (of $58 000) can be traced back a decade to July 2009.

By 2010 I had estimated that a portfolio of around $1.1 million would be required to meet this average income benchmark. I updated this target to reflect more realistic information and evidence on likely sustainable returns in 2016, first setting my previous FI target of $1.47 million.

Finding a benchmark, or a measure of the journey, was therefore an iterative exercise – first begun and then improved on as I learnt more. Along the journey I have tracked, and in some cases continue to track, a number of other metrics. Some of these numbers fall out of existing spreadsheets, others are historical relics in little used Excel workbooks – seeming important for a time, but now neglected and overtaken as meaningful marks of progress. These other metrics include:

  • Asset reserves in weeks. A measure essentially of how long I could last if all employment income stopped tomorrow. This was a significant early metric, and was a comfort to review from time to time. To be able to note that if the worst came to the worst, it might be 6 or 12 months before I could not meet expenses gave a positive feeling of a basic level of security.
  • Passive income expressed as numbers of hours worked at minimum wage. How the portfolio income compared to the Australian minimum wage, i.e. how many hours ‘free work’ did the portfolio complete on my behalf? This is a way of thinking about the additional income a portfolio has produced at no physical cost, to consider the hours of work your dollars are putting in which you do not have to, boosting your financial progress.
  • Remaining deficit to FI target. This is simply the ‘distance still to travel’ number, and towards the mid and late stages of the journey can be more motivating and tangible to focus on than the long progress already made. At this stage, forward progress week to week might be almost invisible in percentage terms, and yet the absolute deficit can still be closing proportionally faster.

Current navigation aids (2017-2019)

My current approach is to keep benchmarking against external standards, but to supplement these with some specific personal FI benchmarks.

In January 2019 I reset my two external benchmarks of progress (Objectives #1 and #2).

  • Objective #1 is a passive income benchmark that is equal to the the median annual earnings of an Australian full time worker ($67 000). That is, approximately 50 per cent of workers earn both less and more than this figure. This is drawn from Australian Bureau of Statistics earnings data, which is updated at least annually, and which therefore can be consistently tracked through time. My logic for picking this benchmark is that any reasonable concept of ‘enough’ should encompass and be somewhat anchored around the earnings of an average worker. To have access to this income, without a single hours paid work being required, represents a significant achievement in freeing oneself all of the potential cares of working career.
  • Objective #2 is set at the approximate equivalent of average Australian full-time ordinary earnings ($83 000). As an average, this ABS benchmark is skewed upwards by a small number of higher earners. This second longer-term goal is designed to reflect a more ‘business as usual’ lifestyle reflecting my personal circumstances. At least in my current phase of life, the lower income of Objective #1 would effectively represent rather than more of a ‘leanFIRE’ concept. As I have previously observed, the income assumed in Objective #2 is closer to the level of expenditure at which I think I would truly become indifferent to working or not.

I have also started tracking these any other measures both against the FI portfolio, but also against an expanded ‘All Assets’ portfolio. This recognises that I have some significant superannuation assets that currently sit outside of the investment portfolio.

This means  I now seek to assess progress on two different bases: first, the current measure based on reliance on the investment portfolio alone and second an ‘All Assets’ measure with superannuation assets taken into account.

The reason for this dual approach was that it was artificial and distortionary to my own thinking about the issue to entirely ignore a substantial potential contributor to a FI target in the form of superannuation, even if it comes with accessibility restrictions and some legislative risk.

Due to these risk and restriction factors, I plan to continue to target financial independence through my private investment portfolio alone, with superannuation providing an additional margin of safety and buffer.

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Cross-bearings and lines of position

My other recent change was to report against an expanded set of benchmarks, beyond just my formal investment objectives.

Since January 2019 I have reported against two additional measures. First, my average annual credit card expenditure (a ‘credit card FI’ benchmark), and the second is an aggregated estimate of total current annual expenditure.

The credit card purchases measure is a way of keeping my financial progress grounded in the reality of what I actually spend. It is currently set at $73 000 per annum, equivalent to the past 12 months of credit card bills. The measure is derived by calculating how much of this expenditure the portfolio is – using the assumed real return rate of 4.19 per cent – producing in income.

This has the benefit of both automatically tracking broad spending trends and adjusting for the inflation I personally experience through time. It is also a highly salient measure. As one stands in front of a paywave machine, it is some comfort to think that portfolio income is paying over 75 per cent of the bill.

As an additional measure I also track actual month to month credit card purchases, and compare them again either current distributions or a 3 year rolling average (as illustrated below).

Measuring - 3yr cardThe total income measure is quite approximate and results from adding some known fixed expenses (such as rates and utilities) that I do not pay through credit card to my total credit card expenditure. It currently totals $96 000. As I have noted, I recognise that it is by no measure a frugal existence, and my good fortune in being able to live in this way.

An example of these measures is given below, using the portfolio position on in the recent May Monthly Portfolio Update as inputs in this case.

Measure Portfolio All Assets
Objective #1 – $1 598 000 (or $67 000 pa) 100.0% 137.3%
Objective #2 – $1 980 000 (or $83 000 pa) 80.7% 110.8%
Credit card purchases – $73 000 pa 91.8% 126.0%
Total expenses – $96 000pa 69.8% 95.8%

Future measures – the end of reckoning?

So what then for the future of benchmarks in measuring the portfolio?

For the moment, the present measures seem sufficient. Recently, however, I have added some additional metrics to watch as the portfolio changes in value.

These new ‘watch’ metrics are the required safe withdrawal rates implied by drawing each required income (i.e. $67 000 or $83 000 as per Objective #1 and 2) from the portfolio. That is, taking the target income levels as fixed, and then calculating what percentage of the portfolio this represents.

Mathematically, this is just a re-arrangement of the method of determining the level of income from the portfolio, but not assuming the current rate of return of 4.19 per cent. So it is equal to the required benchmark income divided by the Portfolio total (so for example, Objective #1 income $67 000/Example Portfolio Level of $1 430 000= 4.68 per cent).

This metric helps make visible exactly the level of investment returns (or safe withdrawal rate) that would be implied by a total reliance on the portfolio at this moment. The reason this is helpful is that a significant set of academic and other analyses cover the issue of the inverse correlation of safe withdrawal rates and equity market cycles.

Put simply, a higher safe withdrawal rate is riskier at time of expensive market valuation (pdf), i.e. good times, than after equity market falls. Conversely, low safe withdrawal rates may be marginally ‘safer’ following substantial equity market falls.

Safe withdrawal rates are typically designed to not fail given a long backtested history of actual market movements over a range of conditions. Yet there is still value in eyeballing the assumed safe withdrawal rate as a cross-check on any decision to cease paid work, and feeling comfortable with that figure.

Observations – Finding a True North  

The power of setting goals and benchmarks cannot be underestimated. My own observations on the process of measuring progress to FI goals are summarised below:

  • Starting is better than finding the best measure. Overall though I have found and discarded many measures and goals along the way, but the choice to start to measure and hold myself accountable for progress was a powerful motivation and tool. Each measure and benchmark helped in its time.
  • Different measures may serve you at different times. Linked to the above, different measures will seem relevant and motivating through different stages of the journey, whether it be ‘reaching zero’, a saving rate or progress towards a specific FI number. Those changes in which measures seem the best fit may actually be important markers of the changing phases of the journey
  • Inflation should be accounted for in any measure. With inflation at historic lows, this may seem unimportant, but with apologies to Trotsky: ‘You may not be interested in inflation, but inflation is interested in you’. FI measures that don’t account for the impact of inflation on purchasing power over years and decades ahead are dangerous to your future lifestyle and goals. Whether it is updating nominal dollar targets regularly for inflation, or exclusively using ‘real’ dollars and rates of return alone, it is critical that goals account for inflation impacts.
  • Measures will be personal choices. The right measures will be deeply personal, influenced by circumstances, preferences, and future goals. There is not likely to be one ‘right’ set designed just for you, even though many of the most common measures (the 4 per cent safe withdrawal rate ‘rule of thumb’ or savings rates) have sound logic behind them.
  • Choose measures that make you consider the whole picture. It is possible to fixate on a single measure for clarity, and for this to provide only a narrow or incomplete view of progress. So behavioural ‘framing’ impacts should be considered when setting measures. That is, consider what the measure might obscure or hide, and its impact on your choices. Examples might be: assets left out of consideration in net worth style measures. Ideally, between them the measures adopted should provide a holistic picture of overall progress, without distorting decision-making by leaving out important aspects of your financial decision-making or circumstances.

Monthly Portfolio Update – May 2019

Posted on by The FI Explorer
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Truth is confirmed by inspection and delay; falsehood by haste and uncertainty.
Tacitus

This is my thirtieth portfolio update. I complete this update monthly to check my progress against my goals.

Portfolio goals

My objectives are to reach a portfolio of:

  • $1 598 000 by 31 December 2020. This should produce a real income of about $67 000 (Objective #1)
  • $1 980 000 by 31 July 2023, to produce a passive income equivalent to $83 000 (Objective #2)

Both of these are based on an expected average real return of 4.19%, or a nominal return of 7.19%, and are expressed in 2018 dollars.

Portfolio summary

  • Vanguard Lifestrategy High Growth Fund – $745 158
  • Vanguard Lifestrategy Growth Fund  – $43 119
  • Vanguard Lifestrategy Balanced Fund – $77 915
  • Vanguard Diversified Bonds Fund – $105 821
  • Vanguard Australian Shares ETF (VAS) – $80 408
  • Betashares Australia 200 ETF (A200) – $246 012
  • Telstra shares (TLS) – $1 937
  • Insurance Australia Group shares (IAG) – $13 376
  • NIB Holdings shares (NHF) – $8 178
  • Gold ETF (GOLD.ASX)  – $85 424
  • Secured physical gold – $13 652
  • Ratesetter (P2P lending) – $23 262
  • Bitcoin – $132 720
  • Raiz app (Aggressive portfolio) – $15 130
  • Spaceship Voyager app (Index portfolio) – $1 883
  • BrickX (P2P rental real estate) – $4 629

Total value: $1 598 624 (+$57 037)

Asset allocation

  • Australian shares – 40.9% (4.1% under)
  • Global shares – 22.3%
  • Emerging markets shares – 2.6%
  • International small companies – 3.3%
  • Total international shares – 28.2% (1.8% under)
  • Total shares – 69.1% (5.9% under)
  • Total property securities – 0.3% (0.3% over)
  • Australian bonds – 5.5%
  • International bonds – 10.5%
  • Total bonds – 16.0% (1.0% over)
  • Gold – 6.2%
  • Bitcoin – 8.3%
  • Gold and alternatives – 14.5% (4.5% over)

Presented visually, below is a high-level view of the current asset allocation of the portfolio.Port Alloc May 2019

Comments

The portfolio has experienced strong growth through the month, with a total increase of around $57 000.

This fifth month of continuous growth has seen an important event occur ahead of schedule. Portfolio Objective #1 – which is the ‘median income’ FIRE target that was the goal set at the start of this record in December 2016 – has been narrowly achieved.Port hist - May 2019

My expectation at the beginning of this year was to reach this particular goal only at the end of 2020. This itself was shifted forward from the original goal of passing a slightly lower median income objective by July 2021. The net result of all of this is that a higher absolute portfolio objective has been reached more than two years early.

This achievement may be temporary, as it comes following the equal second longest run of monthly gains in this record. Just an average monthly fall could easily see the portfolio dip well below the objective again, and a prolonged downturn in share markets could easily lead to major declines which would take some time to recover from. At this stage, given that my final Objective #2 is still some distance away and further accumulation is planned, this prospect does not overly concern me.

The portfolio performance this month largely reflects the same drivers that have dominated performance since the journey began. These drivers have been new contributions and increases in Australian shares (through Betashares A200), particularly since the Federal election. In addition, there has been a significant increase in the price of Bitcoin. This led to a portfolio growth which was the sixth highest in the record to date.Port chng - May 2019

Credit card spending has been significantly lower than average over the past month. It has been the lowest level in six years in fact. As the series below indicates, however, it is a volatile measure.Credit card monthly - May 2019Once financial year 2018-19 figures on distributions are finalised early next month, it’s likely the the red line of distributions, which currently is an estimate based on low December half year figures, will be revised up. This in turn could mean a return to distributions on average coming close to meeting credit card expenses.

Progress

Progress against the objectives, and the additional measures I have reached is set out below.

Measure Portfolio All Assets
Objective #1 – $1 598 000 (or $67 000 pa) 100.0% 137.3%
Objective #2 – $1 980 000 (or $83 000 pa) 80.7% 110.8%
Credit card purchases – $73 000 pa 91.8% 126.0%
Total expenses – $96 000pa 69.8% 95.8%

Summary

Progress over the last few months has been swift and surprising. Timelines set less than six months ago have been met, and the portfolio has entered into the ‘between’ phase of being above my minimum objective, but some distance from my ultimate goal (Objective #2).

Part of the process of adapting to this phase is understanding its true nature – its permanence or otherwise, and looking through short-term movements to try to discern the underlying picture. In short, inspection and delay.

This what lies behind recent posts seeking to analyse the income potential of the portfolio, and longer term trends in distributions and expenses. Seeking the additional data point of what this portfolio delivers currently is the reason I am straining forward to see the size and shape of the end of June distributions.

The advice commonly offered in the financial independence community at this point is crystal clear. Pay less attention to the numbers, and start exploring and building the life you desire now. The advice is so universal, and so intuitively sensible that I do not ignore it. With Australian and global equity markets poised as they are, however, I feel a resisting force going too far down this path. This is mostly stemming from a suspicion that prior to the goal being reached there might be one or more unavoidable challenges to come.

This may be linked to an increased probability of Australian interest rate reductions, and even the entry by Australian monetary authorities into some form of quantitative easing. As inflation stalls, and housing markets decline, the macroeconomic conditions appear less predictable than at any time since 2009. Some of the global financial trends and developments that are of most concern are well discussed in the most recent Incrementum AG In Gold We Trust report, which has as its theme declining trust across the global financial system.

While that outlook might suggest protective action, overall I am comfortable with the extent of my diversification across less-correlated assets. It should be remembered that I felt similar unease two years ago – and that indulging in market timing at that point would have had high opportunity costs.

In any case, more and more it is evident that the performance of the portfolio is not something that can be materially altered by one or two monthly investment decisions. Rather, it is a function of the interaction of unstable markets with the compound effect of hundreds of smaller individual investment contribution decisions taken over the past decade or so across a range of different market conditions.

Following on from my quick Bitcoin and gold correlation analysis last month, I was interested to see this ‘portfolio optimisation’ based analysis on the role of Bitcoin in a portfolio, using just seven years of historical data. Also, this What’s Up Next podcast on finding the right time to retire is a fascinating discussion of the issue of knowing when it is time to put into action FIRE plans. Finally, Aussie HIFIRE has recently pulled together a post highlighting the different voices in the Australian FIRE blogging community for readers.

As winter takes hold, the portfolio is prepared for as yet undefined challenges and storms that may emerge, and I remain intensely curious at what the coming set of distributions will disclose about the distance I still have to travel. One port gained, the next leg of the journey beckons.