Time discovers truth.

Seneca On Anger

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

Portfolio goals

My current objectives are to reach a portfolio of:

• $1 476 000 by 31 December 2018. This should 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 are based on a real return of 3.92%, or a nominal return of 7.17%

Portfolio summary

• Vanguard Lifestrategy High Growth Fund – $692 662
• Vanguard Lifestrategy Growth Fund  – $ 40 404
• Vanguard Lifestrategy Balanced Fund – $73 134
• Vanguard Diversified Bonds Fund – $100 347
• Vanguard Australia Shares ETF (VAS) – $71 485
• Betashares Australia 200 ETF (A200) – $127 999
• Telstra shares – $3 905
• Insurance Australia Group shares – $12 818
• NIB Holdings shares – $5 928
• Gold ETF (GOLD.ASX)  – $76 634
• Secured physical gold – $12 343
• Ratesetter (P2P lending) – $31 360
• Bitcoin – $64 851
• Raiz app (Aggressive portfolio) – $ 12 489
• Spaceship Voyager app (Index portfolio) – $1 431
• BrickX (P2P rental real estate) – $4 844

Total value: $1 332 632 (-$34 134)

Asset allocation

• Australian shares –  40%
• International shares – 18%
• Emerging markets shares – 2%
• International small companies – 3%
• Total shares – 63.5% (1.5% under)**
• Australian property securities – 3%
• International property securities 3%
• Total property – 6.1% (1.1% over)
• Australian bonds – 8%
• International bonds – 9%
• Total bonds – 17.5% (2.5% over)**
• Cash – 1.3%
• Gold – 6.7%
• Bitcoin – 7.2%
• Gold and alternatives – 11.5% (3.5% under)

Comments

Time has revealed truth – it is now quite clear that the portfolio will not reach Objective #1 by the target time of the end of the year. Indeed, the portfolio in absolute value terms has ended the last twelve-month period fairly close to where it began. This is not the first time this type of prolonged portfolio ‘levelling off’ has happened. A similar period of continued investment but little or no growth in the portfolio occurred in 2011. During and beyond this earlier period of stagnant portfolio value, however, regular new investments increased the underlying asset base, and resulted in continued growth in the level of distributions.

This month has seen a fall of over $34 000 in the value of the portfolio. This is one of five significant portfolio falls over the journey so far, and it is the only unbroken month on month fall in this period.

These results and market conditions, however, are not enough to tempt me away from passive index investing.

The record of individual investors pursuing active investments is a sobering one to review, with the average retail equity investors routinely underperforming market indexes by a substantial margin. This margin was measured at nearly 2% on average over the past 20 years by the most recent Dalbar survey covering the performance of US retail investors. Over 10 years, the gap was even wider, at nearly 4%. Remarkably, those investors with average asset allocations only captured around a third of potentially available equity returns over the past 20 years.

Through this period I have continued to invest new savings and maturing Ratesetter funds into Australian equities through the Betashares A200 ETF. Compared to heavily US weighted global investment ETF options, this appears reasonably valued in price earnings ratio terms. The recent falls in Australian and US equities have supported and strengthened this view.

A substantial contributor to the reduced portfolio has been a sharp fall in the price of Bitcoin. In a triumph of mental accounting over economic reality, this has actually not concerned me as much as I might have expected. At more than ten times the purchase price, the current price still feels like an upward push to my overall journey, even as its absolute level has declined from previous highs.

In part, my desire to not sell the holding is driven by continuing belief that it may be an uncorrelated assets with all other parts of the portfolio over the medium term, and that it provides a kind of ‘insurance’ or ‘option’ against unlikely extreme events in mainstream financial markets. So I remain willing to allow it to vary, fall and move dynamically.

Progress

Progress to:

• Objective #1: 90.3% or $143 368 further to reach goal.
• Objective #2: 65.3% or $708 368 further to reach goal.

Summary

In the longer term, as I begin to start thinking about my directions for 2019, I plan to more fully evaluate my targets for foreign and domestic equity market exposure. For the moment, it was interesting this month to listen to Meb Faber’s recent podcast in which he discussed evidence on the overriding importance of keeping costs low.

In particular, he discussed the potential for higher portfolio expenses to completely outweigh the benefits of one of the most fundamental investment settings – initial asset allocation. That is, paying too much for an investment vehicle can overwhelm any potential asset allocation decision made by the investor.

From past trends I appear to be around six months away from reaching my first objective, and am content with this. My focus over the next month will be revising and updating my investment plans and goals, and keenly anticipating the major set of portfolio distributions that are due in early January. These distributions will reveal the most critical measure of progress – actual passive income created over the past half and full year.

** 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.

Who dares not speak his free thoughts is a slave.

Euripides The Phoenician Women

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

Portfolio goals

My current objectives are to reach a portfolio of:

• $1 476 000 by 31 December 2018. This should 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 are based on a real return of 3.92%, or a nominal return of 7.17%

Portfolio summary

• Vanguard Lifestrategy High Growth Fund – $691 943
• Vanguard Lifestrategy Growth Fund  – $40 358
• Vanguard Lifestrategy Balanced Fund – $73 033
• Vanguard Diversified Bonds Fund – $100 197
• Vanguard Australia Shares ETF (VAS) – $72 441
• Betashares Australia 200 ETF (A200) – $118 299
• Telstra shares – $4 072
• Insurance Australia Group shares – $17 535
• NIB Holdings shares – $6 636
• Gold ETF (GOLD.ASX)  – $79 033
• Secured physical gold – $12 691
• Ratesetter (P2P lending) – $33 553
• Bitcoin – $98 423
• Raiz app (Aggressive portfolio) – $ 12 318
• Spaceship Voyager app (Index portfolio) – $1 397
• BrickX (P2P rental real estate) – $4 837

Total value: $1 366 766  (-$57 077)

Asset allocation

• Australian shares –  39%
• International shares – 18%
• Emerging markets shares – 2%
• International small companies – 2%
• Total shares – 61.6% (3.4% under)**
• Australian property securities – 3%
• International property securities 3%
• Total property – 6.0% (1.0% over)
• Australian bonds – 8%
• International bonds – 9%
• Total bonds – 17.2% (2.2% over)**
• Cash – 1.3%
• Gold – 6.7%
• Bitcoin – 7.2%
• Gold and alternatives – 13.9% (1.1% under)

Comments

This month has delivered the largest monthly fall in the overall portfolio level since commencement of the journey. This has resulted from the sharp falls in Australian and international share values from mid-October. The falls have made it unlikely that Objective #1 will be reached by the end of this year as was the target, which is a slight disappointment given how close to the target I was just last month.

The most significant effect this has had is to make me more restless to continue to dollar-cost average into the market, and take advantage of these better valuations. Academic research and history reinforces that key drivers of valuations, such as the equity risk premium (pdf), are variable over time.

The falls also made me curious to examine the record of volatility in the portfolio, to place the events of this month in context. The below graph provides a raw ‘change in value’ measure of the portfolio since the start of this journey. For simplicity, it includes contributions, on the basis that outside of July and December distributions, market movements tend to dominate contributions.

The data is instructive on the issue of volatility in a diversified portfolio. It shows that:

• the portfolio has experienced five down months and 17 monthly gains over nearly two years;
• the median monthly change in value is around $24 000, or 2.2 per cent of the total portfolio – however, gains around this size have only occurred five times;
• the larger falls and gains have each been associated with movement of the Bitcoin component in late 2017 and early 2018, rising and falling respectively;
• last months fall is the largest ever fall, however, it’s worth recording that this has occurred in a generally low volatility environment for shares.

Investment through this period has been almost exclusively in the Betashares A200 ETF, with much smaller ongoing contributions to Raiz and Spaceship. Third quarter dividends of around $2300 from VAS and A200 were reinvested. Receiving significant dividend payments on a quarterly basis is a pleasant and novel experience arising from my entry into ETFs, as most of my significant Vanguard managed fund investments only pay distributions twice a year.

This month I’ve also been following – and occasionally participating in – the ongoing debate on the advantages and disadvantages of Listed Investment Companies compared to index funds or ETFs. The ever thoughtful Pat the Shuffler is convinced there is a ‘cultural shift’ occurring towards LICs, and is adopting that approach for new investments. For my part, I am not as sure that the additional manager and concentration risks are worth taking for any of the claimed benefits.

As one example of the concentration risk mentioned, LICs make active choices to pick equities to be in their funds, including some, excluding others. Such an approach, however, is fraught with the risk of including under-performing equities, and excluding potential out-performers. Such decisions can have very significant impacts on portfolio performance. To illustrate, one study found that for the US market, if an investor had missed investing in the top 20 per cent of equities, total portfolio return between 1989-2015 would have been zero per cent. Nonetheless, the debate has made me curious about the record and conceptual basis of Listed Investment Companies, even if unconvinced at the moment of the added value.

Progress

Progress to:

• Objective #1: 92.6% or $109 234 further to reach goal.
• Objective #2: 67.0% or $674 234 further to reach goal.

Summary

The market movements this month may have either set achieving my targets back a few months, or could herald the beginning of a more substantial weakness which defer their achievement for much longer periods. At the moment, I am relatively unconcerned about missing my target by a few months. I have reached this period of volatility, however, still underweight on my equity allocation, so decisions from here will focus on the path to the right balance of international and domestic shares.

In the period of weakness my allocation to gold – with its long and storied history – has provided some stability and cushioning of overall portfolio volatility, as have bonds. Storms may be ahead, but with each passing investment, the freedom to speak thoughts and weather the consequences grows.

** 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.

Soon you will have forgotten all things: soon all things will have forgotten you.

Marcus Aurelius Meditations, Book VII: XXI

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

Portfolio goals

My current objectives are to reach a portfolio of:

• $1 476 000 by 31 December 2018. This should 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 are based on a real return of 3.92%, or a nominal return of 7.17%

Portfolio summary

• Vanguard Lifestrategy High Growth – $740 894
• Vanguard Lifestrategy Growth  – $ 42 541
• Vanguard Lifestrategy Balanced – $ 75 812
• Vanguard Diversified Bonds – $100 542
• Vanguard ETF Australia Shares ETF (VAS) – $79 787
• Betashares Australia 200 ETF (A200) – $90 985
• Telstra shares – $4 252
• Insurance Australia Group shares – $18 285
• NIB Holdings – $7 020
• Gold ETF (GOLD.ASX)  – $75 242
• Secured physical gold – $12 097
• Ratesetter (P2P lending) – $34 411
• Bitcoin – $101 289
• Raiz app (Aggressive portfolio) – $ 12 916
• Spaceship Voyager app (Index portfolio) – $1 433
• BrickX (P2P rental real estate) – $4 830

Total value: $1 423 843 (+$9 194)

Asset allocation

• Australian shares –  39%
• International shares – 18%
• Emerging markets shares – 2%
• International small companies – 3%
• Total shares – 62.3% (2.7% under)**
• Australian property securities – 3%
• International property securities 3%
• Total property – 6.1% (1.1% over)
• Australian bonds – 8%
• International bonds – 9%
• Total bonds – 17.0% (2.0% over)**
• Cash – 1.3%
• Gold – 6.1%
• Bitcoin – 7.2%
• Gold and alternatives – 13.2% (1.8% under)

Comments

The portfolio has made a smaller advance this month than previously, around a $10 000 increase, leaving around $50 000 remaining to Objective #1 due at the end of the year. This month lower expenses and a bonus has meant more cash to invest, so it is bracing to know those amounts have been added to the portfolio, without much visible effect on total value.

Those acquisitions will tell in future distribution payments, however. Those are due to appear soon from the Vanguard bond fund, the Vanguard Australian shares ETF as well as the Betashares A200 ETF, where most of my recent investment effort has gone. Quarterly payments used to be something barely noticed most years. With movement to greater amounts being invested in ETFs which pay quarterly, however, I am hoping that this year third quarter distributions will actually total enough to allow for a significant one-off reinvestment on their own.

September is also the beginning of tax time in Australia, which has meant a trip to my tax agent, who is retiring (not due to my return, they assured me). My past two posts have focused on the history of my dividend income and expenses based on my records over recent years. Looking back over some of the numbers in past tax returns provides another perspective on the same issues, and one which I still have to fully reconcile back to my dividend records.

The graph below represents trends in taxable investment income. For clarity it is taken from the return items for partnerships and trusts, foreign source income and franking credits (i.e. items 13, 20 and 24, and not including capital gains) over the past eight years.

It shows that taxable investment income at least has not yet reached close to my target Objective #1 of passive income of $58 000, even as in the past year my actual ‘cash in hand’ dividends have reached and exceeded that figure. Measured in percentage terms, better data availability means I can give a much longer series giving a sense of progression over time.

There are no doubt some factors that account for the mismatch between tax return income and received distributions. These could include timing differences, and potentially even errors in how I have added in individual return items. I have particularly sought to avoid double counting and so understatement is also a possibility. The formats and labelling of tax returns are, shall we say, non-intuitive.

This month I have also spent time reviewing evidence on the issue of the right balance between Australian and international shares in my portfolio. Previously, I have not been able to find very good information on this, however, I have recently found an excellent 2013 paper titled Optimal Domestic Equity Allocations for Australian Investors and the Role of Franking Credits published in the Journal of Wealth Management. It has some analysis which seeks to reach some conclusions based on historical market data.

Some key findings of the paper are:

• without franking credit benefits, the past performance of Australian versus international shares would justify a 9-32% domestic allocation;
• with the impact of franking credits, however the optimal allocation shifts to between 32-60%, with higher allocations leading to lower volatility; and
• balancing reducing overall portfolio volatility and minimising the maximum portfolio loss would suggest an allocation to Australian shares in an equity portfolio of around 30-40%.

This analysis is obviously based and dependent on historical data only, and therefore is not necessarily a firm guide to the future. However, to the extent that underlying relationships between Australian and global equity markets remain similar in the future, it does at least provide some data to shed light on the allocation question. There is also an interesting Vanguard note (pdf) on similar questions, that adds the interesting point that this decision needs to also take into account the investor’s overall portfolio allocations.

This month has also been a pleasing period of growth for the blog, as well, with traffic and visitor numbers doubling compared to recent months. So, thank you and welcome to any new readers. Embarrassingly, I discovered one reason only well after the fact was a kind and brief review on the website of Canstar as one of five FIRE bloggers recommended to watch out for.

Progress

Progress to:

• Objective #1: 96.5% or $52 157 further to reach goal.
• Objective #2: 69.8% or $617 157 further to reach goal.

Summary

The research this month will have implications for my future portfolio contributions as I move towards my first goal. Currently, Australian equities make up around 63% of my equity holdings, around 10% more than the portfolio has usually had since inception. This reinforces the potential need to consider global equity ETFs in future investments, and to consider the trade-off carefully between income (dividends) and portfolio diversification. A substantial barrier to this is a lack well diversified global ETF that would avoid exposure to the United States, which appears fully valued.  The world – or US investors at least – appear to have done their share of forgetting.

Regardless, forgetting these darkening clouds in the warming spring weather I have been enjoying walks at lunch-time listening to Aussie Firebug’s weekly listener question podcasts. It’s a great format, and nice to hear some of Firebug’s views applied to listeners’ interesting practical circumstances.

* 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.