Portfolio Income Update – Half Year to December 31, 2019

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Whoever wishes to read the future has to leaf through the past.

André Malraux

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

As discussed in my recent post Between Wind and Water, my goal is to build up a portfolio capable of providing a passive income of around $87 000 by July 2021 (Portfolio Objective).

Passive income summary

  • Vanguard Lifestrategy High Growth – $9 024
  • Vanguard Lifestrategy Growth – $517
  • Vanguard Lifestrategy Balanced – $490
  • Vanguard Diversified Bonds – $86
  • Vanguard ETF Australian Shares ETF (VAS) – $2 904
  • Vanguard ETF International Shares ETF (VGS) – $299
  • Betashares Australia 200 ETF (A200) – $5 845
  • Telstra shares – $43
  • Insurance Australia Group shares – $349
  • NIB shares – $156
  • Ratesetter (P2P lending) – $862
  • Raiz app (Aggressive portfolio) – $130
  • Spaceship Voyager app (Index portfolio) – $0
  • BrickX (P2P rental real estate) – $45

Total passive income in half year to December 31, 2019: $20 750

The chart below sets out the passive income received on a half-yearly basis from the portfolio over the past three and a half years.PIU HY Bar progress Dec 19

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

PIU HY Dist Pie - Dec19

Comments

The total half year passive income from the portfolio was $20 750, or the equivalent of around $3 460 per month. This was around the bottom of the range of my expectations, and it continues the pattern of lower December half distributions.

This result, however, is still around a third higher than the previous comparable December half, and almost double that of three years ago.

Continue reading “Portfolio Income Update – Half Year to December 31, 2019”

Between Wind and Water – Setting a New Portfolio Goal and Timeline

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We shall not cease from exploration
And the end of all our exploring
Will be to arrive where we started
And know the place for the first time.

T S Eliot, Little Gidding

This exploration began three years ago, with an initial objective of building a passive income of $58 000 per annum by July 2021. Since that time, goals have evolved, enabling the bringing forward an achievement of this initial goal.

Each year at this time I have spent time reviewing investment goals and how I plan to reach them.

This post explains findings from my annual review, details my updated portfolio goals and assumptions, and discusses how I will approach my financial independence voyage through 2020 and beyond.

The aim is to have a clear written record of the objectives, approaches and reasoning underlying the plan, to serve as a reference point through the year. The process also enables the updating of plans and assumptions for changes in circumstances, thinking, as well as data and evidence.

Initial landfall and the beckoning final voyage

Last year saw the reaching and passing of the updated Objective #1 more than a year earlier than targeted. This leaves the previous Objective #2 (set at $1 980 000 in 2018 dollars) as the only one left to reach, barring a significant equity market fall.

So to recognise this I intend to reconfigure my goal, simplifying it to a single Portfolio Objective.

This new single objective is to reach a portfolio of $2 180 000 by 1 July 2021. This would produce a real annual income of about $87 000 (in 2020 dollars).

Continue reading “Between Wind and Water – Setting a New Portfolio Goal and Timeline”

Tallying the Stores – Estimating Current and Future Expenditure

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Annual income twenty pounds, annual expenditure nineteen pounds nineteen shillings and six pence, result happiness.
Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
Charles Dickens, David Copperfield

At the centre of most definitions of financial independence is the ability to meet current expenditure through income generated from a portfolio of assets. Earlier this year I started monthly reporting of how close the FI portfolio was to being able to meet an estimate of total annual expenses of $96 000 per annum.

This expenses figure was a rough estimate of total current spending, and resulted from adding some known fixed expenses to my total average credit card expenditure. Yet this figure has seemed higher than anticipated, so this analysis examines what my record of actual past spending suggests for a reasonable estimate of current and future spending.

Just as provisioning a ship for a voyage should take into account actual journey time, my own FI measures need to be as accurate as feasible to make sure plans are set based on realistic estimates. This article – it should be emphasised – is focused on reaching the right estimate for my personal circumstances. Its focus is not offering advice on the process of budgeting or achieving a high savings rate, subjects better covered by others.

Drawing up the manifest – reviewing the initial estimate

The process for estimating total expenditure at around $96 000 was simple in principle. It involved adding a number of known individual fixed expenses to the past twelve months of actual credit card spending. Examples of these fixed expenses include: utilities, local government rates and insurances. They also include some irregular items, such as contributions to housing repairs and a sinking cash fund for car replacement over time.

These fixed expenses are not typically paid by credit card, and so the logic was that the sum of these and the annual credit card total would reach a total overall spending estimate.

In doing this calculation, however, I overlooked that for some large annual expenses that I set aside money for regularly and which I had counted as fixed expenses, I have actually used my credit card for some or all of final payments. This applied to health insurance and some car related costs, for example.

This had the effect of double counting a couple of large expenses, because I was counting both the cash set aside monthly to meet the future cost as an expense, and also the actual expense as incurred through the credit card.

Re-estimating the level of current expenses

Over the past month I have removed the double-counted items and re-estimated all fixed expenses based on the latest actual bills. Indeed, I have allowed some small headroom across the board to allow for modest price increases in the year ahead.

The impact of this is quite significant.

The effect of removing the double-counting is to reduce the monthly fixed expenses estimate from $2 025 to $1 414. This means fixed expenses are around 30 per cent below initial estimates. In turn, this permits some revised estimate of total expenses to be made. Using thus adjusted and corrected data, expenditure appears to be:

  • $7 420 per month or $89 000 per year if based on average credit card expenses of around $6000 per month since 2013; or
  • $7 000 per month or $84 000 per year if based on average credit card expenses of around $5 800 per month over the past year

Both of these figures are below the original $96 000 (or $8 000 per month) total expenditure estimate.

The chart below compares the revised figures against monthly income and expenditure estimates, including the income targets that are contained in both of my FI objectives as well as a historical average of portfolio distributions.

Monthly bar - Expenditure

The revised total expenditure estimate also makes it possibly to present a more accurate and less inflated picture of month to month expenditure compared to portfolio distributions received. Adjusted to account for the new estimate, the monthly progress is set out in the revised chart below.

Monthly exp with new figures - Aug 19

Implications for measures of progress and required FI portfolio

The new estimates for total spending show that I have been materially overestimating current expenditure.

A benefit of recognising this is that it immediately brings forward the progress I have made against the “total expenses” benchmark reported each month. Using last months portfolio value and the $89 000 per year spending estimate, for example, it brings progress to meeting this benchmark from 74.9 per cent to 80.8 per cent.

This is a more than five percent advance in apparent progress simply from a more accurate estimate. The revised spending figure also makes the chart below – the proportion of monthly total expenses met by current distributions, look more encouraging still.Revised total expendit Aug 19

Viewed in a different way, the revised spending figure reduces the total FI portfolio required by around $167 000. This represents months and years of saving and investment now not needed, and potentially returned in the form of free time.

A further implication is that the second estimate above which uses the past 12 month of credit card expenses is within a small margin of my Objective #2 target income (of $83 000 per annum). This gives some confidence that this target is set approximately at the level of my current expenses. That is, reaching this target my current standard of living could be maintained in the absence of any employment income.

Summary 

So far historical data from credit card and additional fixed costs have been drawn on to seek to answer the question: what level of provisioning for future spending is warranted?

The analysis shows that:

  • The total expenditure benchmark being targeted was set too high – When corrected for double counting and using history as a guide average total expenditure is closer to $89 000 rather than $96 000 per annum.
  • A new lower and more realistic benchmark is needed – Based on this, I intend to replace my total expenditure assumption from next month, reducing it from $96 000 to $89 000. This is a conservative figure which is based on the sum of the average credit card expenditure over more than five years and the more recent accurate individual fixed cost estimates.
  • The income target under Objective #2 is close to my current spending level – This lessens the chance that adjusting to the income it produces will be difficult when this this portfolio level is achieved.
  • The past years spending is significantly lower than the average since 2013 – with credit card expenses of around $67 000 annually or $5 800 per month.

Taking the time to carefully consider current and future expenses can be painstaking work. It will be critical, however, to ensure the avoidance of the second of Micawber’s income and expense scenarios, and the need to rest plans for the voyage on the hope that something will turn up.

 

Portfolio Income Update – Half Year to June 30, 2019

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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.