…if any maintain their independence, it is because they are strong.

Thucydides The Pelopponesian War, Book V.84

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

Portfolio goals

My recently revised 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 – $694 784
• Vanguard Lifestrategy Growth Fund  – $ 40 522
• Vanguard Lifestrategy Balanced Fund – $73 808
• Vanguard Diversified Bonds Fund – $102 364
• Vanguard Australia Shares ETF (VAS) – $73 249
• Betashares Australia 200 ETF (A200) – $168 727
• Telstra shares – $4 145
• Insurance Australia Group shares – $12 364
• NIB Holdings shares – $6 408
• Gold ETF (GOLD.ASX)  – $83 188
• Secured physical gold – $13 399
• Ratesetter (P2P lending) – $28 926
• Bitcoin – $53 006
• Raiz app (Aggressive portfolio) – $ 13 461
• Spaceship Voyager app (Index portfolio) – $1 534
• BrickX (P2P rental real estate) – $4 646

Total value: $1 374 531 (+$55 768)

Asset allocation

• Australian shares –  39.9% (5.1% under)
• Global shares – 24.2%
• Emerging markets shares – 2.8%
• International small companies – 3.6%
• Total international shares – 30.6% (0.6% over)
• Total shares – 70.5% (4.5% under)
• Total property securities – 0.3% (0.3% over)
• Australian bonds – 6.6%
• International bonds – 11.7%
• Total bonds – 18.2% (3.2% over)
• Cash – 1.2%
• Gold – 7.0%
• Bitcoin – 3.9%
• Gold and alternatives – 10.9% (0.9% over)

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

Comments

The delivery of half-year distributions from the Vanguard funds and ETFs, as well a recovery in equity markets has led to the strongest monthly growth in the portfolio in the past year. This comes immediately after the weakest period of performance in the previous three months.

The portfolio increased in value by over $55 000 through January, with Australian and international equity, newly invested capital, as well as gold, accounting for the increase.

With the payment of half yearly distributions across early January, the pressing question has been re-investment priorities At this stage, to achieve my new target share allocation, further investment in Australian shares (through the A200 ETF) are required. I have split this investment into two parts, with one half invested already, and the other half due to be invested at the end of the first quarter. Whilst not reflecting the average superior performance of immediate ‘lump sum’ investment versus dollar cost averaging, it nonetheless helps to minimise the risk of a single ill-timed purchase.

One of the regular steps of my annual investment review process is to look at the level of my required emergency fund. This year I put in place a new estimate of the required amount: a target of $83 000, equal to the income target of Objective #2. Previously, I have typically based this amount purely on 12 months of average full-time earnings, with no adjustments.

Over the past two years, however, as portfolio distributions became a more significant factor, I have resolved to factor an annual estimate of these distributions into the required emergency fund level. That is, I now reduce the required emergency fund level, by an estimate of average distributions that could be expected to be delivered by the portfolio over a year. To ensure this adjustment is conservative and stable, I have based the estimate on an average of the past 5 years of distributions (which came to around $45 000 per year).

For 2019, applying this approach has lowered my emergency fund requirement from around $60 000 to $38 000. The cash surplus arising from this reduction has been invested with the same timing as re-investment of recent distributions. As distributions from the portfolio grow, the emergency fund requirements will therefore automatically decrease from year to year. The emergency fund is kept in a liquid high interest savings account.

Overall, the portfolio in absolute value terms has ended the last rolling twelve-month period well above where it began. Through the last two years the portfolio has grown by almost 40 per cent, despite some challenging months in equity markets.

Through this period I have continued to invest new savings and maturing Ratesetter funds into Australian equities through the Betashares A200 ETF.

The holiday period has provided lots of opportunity for looking over the journey so far. A particular focus has been consciously prioritising a greater balance between Australian and international shares. One reason for doing this is to diversify away from the risks of the Australian equity market, and ensure that progress towards FI is not unduly relying on an assumption that Australian equity will forever continue it’s positive history performance. A study in 2010 by Professor Wade Pfau highlighted that internationally markets that permit a safe withdrawal rate of 4 per cent are the exception, not the rule. In fact, only in 4 out of 17 equity markets studied, would such an approach have been safe, with many developed market equity markets supporting far lower safe withdrawal rates of between 1-3%.

Progress

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

Summary

The portfolio moved perceptibly towards my first objective this month. Interestingly, it is also closing in on Objective #2 on an ‘All Assets’ basis (which includes superannuation).

The recent downdrafts from the market, and lower portfolio distributions than expected in January has, however, tempered any perception that progress towards the goal will be either smooth or inevitable. Risk inevitably exists in the market, as is covered in a quite clever and comprehensive way here by high profile US finance academic Aswath Damodaran in a recent fascinating note on the many faces of risk.

This month, as well as taking my chances discussing some of the weaknesses in the implicit claims for Listed Investment Company focused investment, I have been absorbing a few new pieces of research, this one about the ‘buckets’ approach to investment, and also caught up with pieces from new Australian bloggers HisHerMoneyguide and Late starter FIRE. For a different perspective on buckets, this article from Laurence Siegel is also thought-provoking. Finally, this analysis of the futility of market timing provided welcome reassurance as I set in place my plan for dollar cost averaging previous distributions into the market on a staggered basis, and this podcast from Mad Fientist was a thoughtful discussion of the real goals, and some challenges of the retire early part of FIRE.

He who has begun has half done.

Horace Epistles (Book I.ii)

Year in review

This year began with resetting my objectives to reach a portfolio value of $1 476 000 by the end of the year, to support an annual passive income of around $58 000.

This goal has not been met, despite the overall portfolio coming within about $60 000 of the target in September. Just as expected at the start of 2018, it did indeed prove a more challenging environment for closing on this goal than the previous year.

In fact, instead of reaching the target as hoped, the portfolio actually finished the past year around 3 per cent below where it commenced at the start of 2018, despite significant investments regularly though the year.

The reasons for this are two-fold.

First, the fall in the price of Bitcoin from its highs early in 2018 has provided a steady, and sometimes sharp, headwind to the journey. Through the year the resulting loss of around $130 000 simply could not reasonably be made up for, even assuming good performance of all other assets. Bitcoin has reduced from 14% to just 4.5% of the portfolio, so perhaps the only positive to take from this grinding performance is that it will not have the ability to have this same kind of depressing effect on next years record. Nonetheless, I am happy enough to retain my current holdings. This is because I agree with sentiments from Nassim Taleb that it represents a unique form of insurance policy against very poor future outcomes.

Second, recent falls in equity markets have worsened the results. Given normal volatility in shares, however, this has not concerned me or reduced my intention to continue to invest in equities. What is perhaps more interesting than a negative single year performance of shares is that 2018 has been highly unusual in the high proportion of all asset classes experiencing negative returns.

Overall, the failure to meet my objective #1 is not particularly surprising or a source of dissatisfaction. It has been on the cards for the last few months, and I have had time to adjust. An additional factor has been that my nominal passive income target of $58 000 per year has been the same since July 2016, unadjusted for inflation, or median income movements. This has meant that I have known for some time that I would not be likely to feel comfortable with it as a defining triggering point of financial independence. Thus it has felt like missing a target that had more symbolic than practical or intrinsic meaning.

Finally, I’m sanguine about missing the target because I think that with the passage of time and ongoings savings, passing that particular value will be most likely be achieved, even if perhaps 6-18 months later than anticipated.

Rather, the achievements of this past year that stand out are:

• Continued exploration: this has included switching from use of Vanguard retail funds to regular investments in low cost ETFs such as the Betashares A200, using a low cost broker, lowering management costs on new investments, and trying new Fintech providers such as Spaceship.
• Following the course: having set an asset allocation plan, this has driven portfolio choices that inertia and absence of a plan would not have, such as a systematic reduction in my Ratesetter holdings, regular new investments in Australian equities during periods of volatility, and stopping allocation of any new funds to bonds.

A pleasing part of the past year has also been the growth in readership, which I am grateful to readers for. This has genuinely been a pleasant surprise, and has been somewhat accelerated by a kind profile of Australian FI bloggers in the April edition of Money Magazine.

As I do each year at this time, I have been reviewing my investment policy and looking at possible new goals. I have also been stress-testing my plans, assumptions and asset allocations.

Before finalising these, as with last year, I want to understand the shape and level of fund and ETF distributions arising from the past six months. This means waiting until December distributions are finalised or announced. I am looking forward to sharing these updated plans – including possibly some new portfolio objectives – in the next couple of weeks or so.

Monthly Portfolio Update – December 2018

This is my twenty-fifth portfolio update. I complete this update monthly to check my progress against my goals which, as mentioned, are likely to be evolving soon.

Portfolio goals

For the moment, however, my objectives were to reach a portfolio of:

• $1 476 000 by 31 December 2018. This would produce a real income of about $58 000 (Objective #1).
• $2 041 000 by 31 July 2023, to produce a passive income equivalent to $80 000 in 2017 dollars (Objective #2)

Both of these were based on a real return of 3.92%, or a nominal return of 7.17%

Portfolio summary

• Vanguard Lifestrategy High Growth Fund – $669 046
• Vanguard Lifestrategy Growth Fund  – $39 448
• Vanguard Lifestrategy Balanced Fund – $72 167
• Vanguard Diversified Bonds Fund – $101 645
• Vanguard Australia Shares ETF (VAS) – $71 070
• Betashares Australia 200 ETF (A200) – $138 346
• Telstra shares – $3 799
• Insurance Australia Group shares – $12 208
• NIB Holdings shares – $6 240
• Gold ETF (GOLD.ASX)  – $82 863
• Secured physical gold – $13 365
• Ratesetter (P2P lending) – $30 131
• Bitcoin – $59 570
• Raiz app (Aggressive portfolio) – $ 12 584
• Spaceship Voyager app (Index portfolio) – $1 430
• BrickX (P2P rental real estate) – $4 851

Total value: $1 318 763  (-$13 869)

Asset allocation

• Australian shares –  38%
• International shares – 24%
• Emerging markets shares – 3%
• International small companies – 4%
• Total shares – 68.9% (3.9% over)**
• Australian property securities – 0.4%
• Total property – 0.4% (4.1% under)
• Australian bonds – 7%
• International bonds – 12%
• Total bonds – 18.8% (3.8% over)**
• Cash – 1.3%
• Gold – 7.3%
• Bitcoin – 4.5%
• Gold and alternatives – 11.8% (3.2% under)

Presented visually, below is a high-level view of how the asset allocation of the portfolio currently looks.

Comments

The portfolio has fallen short of the target, reflecting the factors discussed above. Over this month I have concentrated on continuing to make new investments though the significant equity market volatility, while undertaking some of the reflection and research required for the review of my investment policy and goals.

For the sharp-eyed a small but significant change in allocation seems to have occurred in the past month. This is because in the course of reviewing of my investment plans and working sheets I have had time to integrate some larger than initially expected changes made to the Vanguard Lifestrategy retail funds standard pre-set asset allocations.

The effect of this has been to lower my property security allocation to almost nothing, and mildly increase my share allocation. It has also shifted the balance between Australian and foreign equities. Rather fortuitously, this has moved in the direction I was actually intending to pursue, increasing my international equity exposure, which had previously stagnated as my Australian equity ETF index purchases occurred through this year.

The last few months have seen the largest ever declines in my overall portfolio, giving a sense of ‘treading water’ while making regular purchases into a falling, or at best sideways, market. Positively, this has seen purchases of A200 at the lowest prices I have paid so far. This adds some minor upside to the generally unhappy story of portfolio value over the year set out below.

Progress

Progress to:

• Objective #1: 89.3% or $157 237 further to reach goal.
• Objective #2: 64.6% or $722 237 further to reach goal.

Summary

As summer heat has kept me inside, there has been ample time to take a long perspective on the journey so far, and the shifting priorities and themes of the year. What has become more apparent is the sense of building momentum, particularly in the passive income element of the portfolio.

Calculating the other day, I discovered that 2018 was, in paper value terms, the most difficult, loss-making part of my long journey so far. That it does not feel this way is testament to my increasing focus on and confidence from two other components of the journey – portfolio income, and its steadily growing capacity to meet regular life expenses.

The next few days, and specifically knowledge of distributions that are due to be calculated and paid, will prove important for my future sense of the speed of progress. It’s not impossible that distributions, like the portfolio value, could go backwards compared to the last few periods. The level of distributions will determine other important parts of my investment plan – such as required emergency fund levels, and insurance coverage levels.

So as 2019 begins, progress continues, and distributions and the new information they provide will flow into my next updated set of plans for financial independence.

** These variances have been recalculated from this month onwards to be in reference to my longer term allocation targets for equities and bonds (65/15), rather than a previous lower transitional target of 61-62 over the past two years.