Reviewing the Log – Trends in Passive Income and Expenses

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The world is too much with us; late and soon
Getting and spending, we lay waste our powers
Little we see in nature that is ours
Wordsworth The World is Too Much With Us

Reading the signal flags

As the journey progresses, some questions are increasingly pushing themselves forward. Questions such as: what does achieved financial independence look like in practical day-to-day terms? Will I recognise it when I see it? The answers to these questions will help recognise the length of the journey still to travel, and the signposts of arrival.

Over the last few years I have been recording my credit card expenditure, and more recently, have started comparing this against the income produced by the portfolio. This is on the theory that if my investment income matches or exceeds average credit card charges each month, then at one level some variant of FI has been achieved (is “credit card FI” copyrighted?). In July I mentioned this, and provided a snapshot. This post seeks to dig deeper into this data, to better understand where I am from a different perspective.

The portfolio goals  I am working to are built from target incomes, which are then translated into lump sum targets, using an assumed average return (of 3.92%). Each month I report a percentage progress towards these goals. Currently I’m about 95 per cent of the way to Objective #1 and 70 per cent of the way to Objective #2.

There are some interesting subtleties to bear in mind in using a percentage based measure of progress, that are well discussed here. The goals also have a time frame based on progress to date, which means, for example, that I noticed the other day I was officially only around 100 days from Objective #1.

Each of these are useful measures for understanding progress, but at its most basic, financial independence is having a steady passive income sufficient to meet required daily expenses. There are different variants of this concept, with ‘leanFIRE’ and ‘FATfire’ referring respectively to a capacity to meet a modest, if not minimal lifestyle, or the capacity to live a relatively unconstrained, comfortable lifestyle from passive income.

Constant bearing, decreasing range

To better understand the answers to the questions above, I have stepped beyond credit card expenses records, to look at total expenditure from all sources. This includes items such as rates, energy and utility costs, day to day cash, as well as contributions to irregular major expenses such as holidays, house and car repairs, as well as eventual car replacement. It does not include income taxes.

This record has never focused on frugality of living expenses, or detailed expense analysis to a significant degree, and will not start doing so now. Rather, what I sought to understand was an estimated total cost of maintenance of my current lifestyle. Over the past few years my total credit card expenses have averaged around $72 600 per year. Adding all other expenses not paid by credit card ($24 300) gives a total current expenses of $96 972 (or around $8 081 per month). The figure below sets out a ‘credit card only’ and a ‘total expenses’ series against an averaged measure of monthly portfolio distributions. The green line effectively represents actual credit card expenses, added to an equal monthly contribution of other non-credit card expenses.

Total and credit 3 - Sept 18

This shows that while on average portfolio distributions have been around equal to credit card expenses since the middle of 2017, there is still some further progress before portfolio distribution can regularly meet total current expenses. As that is a quite busy graph, I have produced a simplification of the same data, expressing instead the proportion of total expenses being met by portfolio distributions over time.

Total expenses % of dist 2 - Sept 18

This data, and the trend line, shows steady progress through the last five years. Distributions have risen from meeting only around 20 per cent of expenses, to now meeting around 80 per cent. On current trends, it would appear that the next several months could see it passing the point at which annual distributions regularly fully meet my current lifestyle expenses.

Summary – Running before the wind

By definition, this log can only be a record of what has been. There are dangers in linear extrapolation on any course. For this moment, progress seems relatively steady and consistent beneath month to month market variations.

Yet there are a few cautionary points to observe:

  1. Right target? My current estimated total expenses are above those assumed in my portfolio goals ($96 000 compared to $80 000 per annum), potentially implying the latter need to be revisited.
  2. Irregular estimated expenses – The total expense estimate is influenced by some broad estimates of major but irregular spending requirements, which could turn out differently than expected.
  3. Both income and expenses are variables – while portfolio income has been mostly stable over the long-term, there can be large variations in half-yearly totals. It is not impossible for future periods of higher expenditure to coincide with lower portfolio income.

The answer to the questions I posed may well be that I will not immediately recognise the cross-over point, that I will need to actively monitor for it. In the immediate term, it’s possible I will drift into a position in which notionally my entirely ordinary salary income is available to add to the portfolio, increasing portfolio growth strongly. This is an intriguing and motivating part of the mathematics of long-term portfolio investment.

As the portfolio reaches towards full expense replacement, there is a duality. Amongst steady but small changes and weekly habits it feels as if an inflection point, or some form of phase transition is creeping upon the stage.  The task is to measure, notice, reflect and act on the result.

Wind in the Sails – A History of Portfolio Distributions

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Gradually, and then suddenly.
Hemingway The Sun Also Rises

The wind stirs and grows

In this journey portfolio distributions have represented an extra wind in the sails, whose contribution should not be underestimated. In fact, total distributions over the past 19 years total over $360 000, or more than 25 per cent of the total current value of the portfolio.

When I started tracking portfolio income, distributions represented just a weak breath of wind. They made a tiny monthly contribution of $27 or so. This has since turned into a strong gust, with over one-third of the total value of all distributions being earned in the past two financial years.

By way of contrast to this recent strength, it took 13 long years of saving and investing to earn the first one-third of total distributions received. Similarly, it took 11 years of saving and investing for portfolio distributions to break decisively above around $10 000 per year. The below figure sets out past recorded distributions in 2017 dollars.

Port distThe contributions of different investments have changed over time. A significant part of very early income was actually linked to cash holdings in high interest savings accounts.

Through a process of gradual investment in Vanguard’s high growth indexed fund, the distributions from this source have become dominant. This source now drives overall distributions performance, save for some growth in Australian shares ETFs in the past year or so.

It is noticeable that there is variability, including peaks and falls. In some years capital gains were realised by funds and paid out, meaning peaks in what are distributed gains that go beyond income or dividends. An example of this is achieving nearly $20 000 of distributions in 2005-06, a level not exceeded again until five years later in 2010-11, which itself was a peak not exceeded for another five years.

Measuring the wind – the rate of portfolio distributions

To help forecast the level of future portfolio distributions and track progress to my goals, I have constructed estimates of the portfolio income rate of the past two decades. This is calculated by determining the total distributed income over the financial year by all portfolio assets, and dividing it by the average portfolio level half way through the year. Note that where large movements occur unevenly through a year, some minor inaccuracy is introduced.

The theory is, instead of seeking to project forward a trend in the absolute level of distributions, why not seek to observe what the historical level of portfolio income has been produced, based on the average of the total portfolio.

Average port distOver ten years, the median level of distributions from the portfolio has been 4.4 per cent. The mean average has been higher, at 5.1 per cent. This now allows me to have some degree of certainty around the likely bounds of future distributions from any projected portfolio level.

There are some anomalies in the figures, caused by things such as a major house purchase changing the size of the portfolio, and the adoption and abandonment of a range of different financial products. Through the period, also, interest rates have been steadily falling.

One factor that does not seem to have been a particular driver of variability is asset allocation. This is perhaps surprising as over the past decade non-income producing holdings (gold and Bitcoin) have been introduced and started to formed a small part of the portfolio – generally 5 to 10 per cent.

Although in general the portfolio has moved to very low cash levels and a reduced level of fixed interest products through time, overall equity allocation has remained within a few percentage points of 60 per cent since 2007.

Fair winds and following seas?

The past two years have seen slightly higher than usual distributions levels. It remains to be seen whether these are temporary anomalies. Similarly, the absolute level of portfolio distributions in the past two years has been decisively highly than historical levels.

This leads to mindfulness of the potential for future reverses in the absolute level. Nonetheless, applying the historical 4.4 per cent average to my current portfolio level still produces a forecast annual distribution income of around $62 000, above the first of my current targets.

Such projections can’t protect against storms ahead, but still provide a comforting thought on the continuing journey.

Monthly Portfolio Update – August 2018

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Make the best use of what is in your power, and take the rest as it happens.
Epictetus

This is my twenty-first 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 – $743 491
  • Vanguard Lifestrategy Growth  – $ 42 691
  • Vanguard Lifestrategy Balanced – $ 76 095
  • Vanguard Diversified Bonds – $100 542
  • Vanguard ETF Australia Shares ETF (VAS) – $79 787
  • Betashares Australia 200 ETF (A200) – $90 985
  • Telstra shares – $4 132
  • Insurance Australia Group shares – $19 284
  • NIB Holdings – $7 824
  • Gold ETF (GOLD.ASX)  – $76 095
  • Secured physical gold – $12 212
  • Ratesetter (P2P lending) – $35 692
  • Bitcoin – $106 623
  • Raiz app (Aggressive portfolio) – $ 12 910
  • Spaceship Voyager app (Index portfolio) – $1 329
  • BrickX (P2P rental real estate) – $4 823

Total value: $1 414 649 (+$41 435) 

Asset allocation

  • Australian shares –  38%
  • International shares – 18%
  • Emerging markets shares – 2%
  • International small companies – 3%
  • Total shares – 61.5% (3.5% under)**
  • Australian property securities – 3%
  • International property securities 3%
  • Total property – 6.2% (1.2% over)
  • Australian bonds – 8%
  • International bonds – 9%
  • Total bonds – 17.3% (2.3% over)**
  • Cash – 1.3%
  • Gold – 6.4%
  • Bitcoin – 8.7%
  • Gold and alternatives – 15.1% (0.1% over)

Comments

Overall, the portfolio has now closed above $1.4 million for the first time since the heights of the temporary Bitcoin fever early this year, with growth of over $41 000 this month. This means I am now only around $60 000 away from achieving my first objective. In theory, this could occur within a few short months if markets move positively. Alternatively, a market setback could see it receding back to the target date of the end of this year, and even beyond. The sensation of seeing one finish line approach is interesting.  A summary of the progress of the portfolio through time can be seen below.

Portfolio history2

From one perspective, it feels like a significant, life-changing milestone is in prospect. On the other hand, however, it leads to pondering with a greater focus than ever before about precisely what that objective would mean, in living standard terms, compared to other objectives.

As an example, I can trace back the goal of providing for a stream of passive income of $58 000 to at least July 2009. Back then, my return assumptions were optimistic, and I envisaged the goal being achievable around 2020. The movement of inflation means that the target of $58 000 is around the median Australian income, but below the mean average. One of the issues I intend to review in January is whether I need to adjust this target to take into account inflation and average income growth from when I originally made it.

My major new investments have focused on Betashares A200, the lowest cost vehicle to build Australian equity exposure. From May of this year, I have invested over $88 000 in this investment vehicle. This has a weighting of 33 per cent to Australia’s financial sector, so with the ongoing Royal Commission and future regulatory risks, it is not an entirely anxiety-free prospect. My reasoning for continuing to invest is my long-term interest in the dividend component of the return, the fact that the Australian market continuing to trade closer to its historical average, and a concern to avoid currency risks and US market valuation risk from other globally diversified ETF options.

I am considering making further investments in BrickX, as they have two new properties available, which would help further diversify the very small residential property allocation in my portfolio. However, the entry transaction fees are very high (1.75%), and the available rental yields looks extremely unattractive. Overall, with current declines in the residential property markets, it does not seem a fruitful time to extend my exploration of this area in any more significant way.

One savings focus over the past month has been on reconsidering my insurance requirements, based on likely future distributions flows. Previously, I adopted a highly conservative approach to both income and life insurance that almost completely ignored the income stream of future dividends from my portfolio. I have updated these policies to at least partially reflect likely annual distribution payments – based on a backward looking average of the past four years of distributions. This has allowed me to reduce my overall level of coverage to target the income assurance level right for my circumstances, while saving on unnecessary insurance premiums. This has led to over $600 additional contributions to my investment portfolio, and will lock in an annual saving as well.

Finally, it feels like it has been a month of lively debate, including on Reddit, about different investment approaches. I have enjoyed these, as it helps test and strengthen my thinking, and be clear about why I adopt my current approach of a passive index-based and diversified approach, with a focus on total returns (capital and dividends). One of the reason for this diversified approach, compared to narrow Australian equity only approaches, is because high Australian dividend yields likely come with lower overall equity returns compared to those countries with lower dividends. The case for passive investment is nicely detailed in video here. In between time I have been enjoying reading new blogs from the growing Australian FIRE community, such as Path to Fire and HIFIRE.  I have also been engrossed in a fascinating audiobook version of The Bitcoin Standard, an economic perspective on the history of money and possible future and value of Bitcoin.

Progress

Progress to:

  • Objective #1: 95.8% or $61 351 further to reach goal.
  • Objective #2: 69.3% or $626 351 further to reach goal.

Summary

Approach my first objective has a feeling of required natural caution surrounding it. Like stepping over a crack in a rock floor, or approaching an unknown cliff edge, one is never entirely sure of the footing or terrain on the other side. It’s possible that this sensation will be one I live with for one, two or three years, depending on market movements and any number of possible developments. I find myself caught between divergent feelings of restlessness, and also a desire to slow down and mentally imprint what this phase of the journey feels like.

** 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.

Monthly Portfolio Update – July 2018

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Mens fortunes are on a wheel, which in its turning suffers not the same man to prosper for ever.
Herodotus

This is my twentieth 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 – $727 907
  • Vanguard Lifestrategy Growth  – $41 957
  • Vanguard Lifestrategy Balanced – $75 075
  • Vanguard Diversified Bonds – $100 122
  • Vanguard ETF Australia Shares ETF (VAS) – $78 653
  • Betashares Australia 200 ETF (A200) – $55 263
  • Telstra shares – $3 785
  • Insurance Australia Group shares – $20 083
  • NIB Holdings – $6 768
  • Gold ETF (GOLD.ASX)  – $75 509
  • Secured physical gold – $12 058
  • Ratesetter (P2P lending) – $38 431
  • Bitcoin – $119 600
  • Raiz app (Aggressive portfolio) – $12 077
  • Spaceship Voyager app (Index portfolio) – $1 215
  • BrickX (P2P rental real estate) – $4 711

Total value: $ 1 373 214 (+$34 066) 

Asset allocation

  • Australian shares –  36%
  • International shares – 18%
  • Emerging markets shares – 3%
  • International small companies – 3%
  • Total shares – 59.5% (1.5% under)
  • Australian property securities – 3%
  • International property securities 3%
  • Total property – 6.2% (1.2% over)
  • Australian bonds – 9%
  • International bonds – 9%
  • Total bonds – 17.8% (2.8% over)
  • Cash – 1.3%
  • Gold – 6.4%
  • Bitcoin – 8.7%
  • Gold and alternatives – 15.1% (0.1% over)

Comments

The allocation of distributions for the last half-year has been the most significant decision over the past month. After some thought my allocation decision was to do three things:

  • $1 000 investment in Spaceship index – the logic being that this has no fees, is consistent with indexed globally diversified approach, and putting a significant amount at risk will better test my views of its performance.
  • $10 700 set aside for future tax liabilities – this is to avoid having to sell an investment to meet a future ‘surprise’ or higher than expected tax liability, arising from capital gains.
  • $29 000 investment in A200 Australian equity ETF – this is due to this being the lowest cost vehicle for exposure to Australia equity markets, and is consistent with seeking to reach my target equity allocation. The Australian equity market continues to appear more fairly value on a dividend yield and price to earnings ratio than global markets (taking into account US valuations).

Seeing such a significant re-investment in the portfolio has felt motivating, and increased the sense that momentum is shifting. Each fortnight this has been added to by a regular additional investment in A200, supplemented by the slow draw down of Ratesetter loans as they mature.

Movement in my portfolio has been limited, aside from distributions. My reliance on A200 for recent investments is slowly building my Australian equity exposure. At some point, I will need to consider ‘how much is too much’ domestic exposure.

With past financial years distribution finalised, my curiosity also turned to the question touched on in my last post, that is, the proportion of my credit card expenses that can now be said to be notionally met by portfolio distributions. After much exploration with spreadsheets, averages, and assumptions the results are below. Whichever way the data is analysed, around September of last year I reached the ‘cross over’ point (the concept made popular by Your Money or Your Life) in terms of credit card expenses.

Credit and expenses2

Credit card expenses are obviously volatile from month to month, and the distributions line is an averaged per month figure from the total annual distributions. Obviously, all of my expenses don’t occur through my credit card – though I would estimate around 80-90 per cent do. This means it is just short of a full ‘cross over point’. Nonetheless, it is an arresting and motivating fact to consider that each time I use my credit card to buy an essential item, the portfolio is notionally paying that expense.

Over the past month, I have also signed up to join the waitlist for Xinja, a new app based banking product, featuring a pre-paid card and spending categorisation. I need to study this further, as functionality seems restricted to joining a queue at the moment. Making someone join a queue for access to services seems a non-intuitive way to signal a commitment to disrupting traditional banking models, but my curiosity is still piqued. Finally, I listened to an interesting Equity Mates podcast with the founder of Raiz (formerly Acorns), who gave an insight into where that fintech product was going in the future, and the challenges facing fintech startups.

Progress

Progress to:

  • Objective #1: 93.0% or $102 786 further to reach goal.
  • Objective #2: 67.3% or $667 786 further to reach goal.

Summary

Looking at the graph above of credit card expenses versus portfolio income feels like a peculiarly tangible manifestation of the gradual approach of financial independence. It’s provided an extra impetus to be careful of what I purchase, and to try to keep the blue line below the red. July distributions will hopefully increase my future portfolio income, even as I continue to expect a significant reversal in capital markets over the coming year.