Monthly Portfolio Update – October 2019

Posted on November 1, 2019January 16, 2022 by The FI Explorer

And coming events cast their shadows before.

Thomas Campbell, Loichiel’s Warning (1802)

This is my thirty-fifth 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 passive 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 per cent, or a nominal return of 7.19 per cent, and are expressed in 2018 dollars.

Portfolio summary

Vanguard Lifestrategy High Growth Fund – $773 028
Vanguard Lifestrategy Growth Fund – $44 094
Vanguard Lifestrategy Balanced Fund – $80 383
Vanguard Diversified Bonds Fund – $108 964
Vanguard Australian Shares ETF (VAS) – $139 698
Vanguard International Shares ETF (VGS) – $27 138
Betashares Australia 200 ETF (A200) – $259 380
Telstra shares (TLS) – $1 860
Insurance Australia Group shares (IAG) – $13 847
NIB Holdings shares (NHF) – $8 412
Gold ETF (GOLD.ASX) – $98 755
Secured physical gold – $15 979
Ratesetter (P2P lending) – $17 791
Bitcoin – $147 130
Raiz app (Aggressive portfolio) – $16 931
Spaceship Voyager app (Index portfolio) – $2 240
BrickX (P2P rental real estate) – $4 410

Total value: $1 760 040 (+$30 378)

Asset allocation

Australian shares – 42.0% (3.0% under)
Global shares – 22.6%
Emerging markets shares – 2.4%
International small companies – 3.1%
Total international shares – 28.1% (1.9% under)
Total shares – 70.1% (4.9% under)
Total property securities – 0.3% (0.3% over)
Australian bonds – 4.8%
International bonds – 9.9%
Total bonds – 14.7% (0.3% under)
Gold – 6.5%
Bitcoin – 8.4%
Gold and alternatives – 14.9% (4.9% over)

Presented visually, below is a high-level view of the current asset allocation of the portfolio. Asset pie Oct 19

Comments

This month the portfolio grew by just over $30 000 in total, building on the previous month of growth. Progress bars - Oct 19

The equity component of the portfolio has grown, including through new contributions and another part of the June distributions being ‘averaged into’ equity markets.

The only other major changes in the monthly value of the portfolio have been the result of gains in the value of equity holdings and a sharp upward movement in the price of Bitcoin. 12 months progress

This month marks the notional passing of one of the additional FI benchmarks set at the beginning of the year – ‘Credit card FI’. This benchmark is estimated on the basis of reaching a portfolio value where the annual assumed real return of 4.19 per cent could in theory fully meet average annual credit card expenses of $73 000.

This benchmark is notionally met in that sense, and it is also close to being met on a far more practical and tangible basis also. The actual gap between a trailing average of distributions paid and card expenses has now fallen to less than $300 per month.

Closing gap - Oct 19 Even so, it is important to note that this narrow gap could stabilise or modestly rise once forthcoming December distributions form part of the average, replacing a higher placeholder assumption based on June’s figures.

Quarterly distributions from Betashare’s A200 ETF and Vanguard’s Australian shares ETF (VAS) were paid this month. These distributions, in addition to another staggered reinvestment of June distributions were invested in the market.

They have been mostly placed into VAS, to obtain the benefit of accessing a slightly wider range of holdings at a comparable fee, as well as to reduce any (admittedly small) risk and volatility in future returns and payout levels between A200 and VAS.

To maintain the target balance for international (40 per cent) and domestic equities (40 per cent), a smaller additional investment was also made into Vanguard’s International shares ETF (VGS).

Sighting harbours and early arrivals – revising the FI target date

A focus of thought in the two months ahead will be the expected timing of reaching my FI Objective #2.

This goal is current set to July 2023. In setting this original target timeframe I used approximate and conservative estimates, based on previous average total portfolio increases over the past five years.

This method effectively ignored extra contributions arising from any above average portfolio distributions, or any return impacts, given the relatively short time until both targets. As such, it represented a clear simplification of reality. Achievement of the target – I reasoned at the time – would inevitably be impacted by market fluctuations and this meant constructing spuriously exact yearly forecasts of the impacts of average returns would not be worthwhile.

What has become clear since meeting Objective #1 more than 18 months earlier than expected is that more rapid progress was also being made towards Objective #2. To understand and explore this progress further I have applied a few estimation techniques to start understanding possible revised trajectories.

These estimate approaches included:

simple extrapolation from past progress over a long time period
using the median monthly progress since 2017; and
assuming no investment returns at all, and reliance just on contributions.

The results of the different estimation approaches being applied were broadly consistent, with projections of Objective #2 being reached at least two years ahead of schedule. A further interesting fact was that average assumed investment returns alone would be sufficient to carry the portfolio to the original target level by mid-2023. Indeed, even if the portfolio suffered a one-off 33 per cent fall in equity values tomorrow – as is quite possible – modelling suggested the target would still be likely to be met early.

With two months to go until a full portfolio review, this indicates that it may be useful to reset this target to an estimate that more closely aligns with progress to date, whilst still retaining a respectful regard for the critical role that market variations can have in this phase of the journey.

Casting the shadow before – a better approach for estimating distributions?

At this time of year December distributions begin to cast their shadow forward, as the previous July distributions recede.

Seeking to estimate the approximate level of future distributions has been an ongoing interest, and has been looked at previously in both the Set and Drift and Wind in the Sails posts. The level of distributions is a solid and important marker of how far the journey has progressed.

This month I found time to fully develop an expanded data set to allow a better estimate of likely distributions. From the website of the relevant Vanguard retail funds, as well as the sites for the ETFs VAS, VGS and A200 I was able to download the available histories of distributions.

These stretched back a decade for some funds, and five years for VAS and VGS, but substantially shorter for A200. This enables the estimation of average payouts (in cents per unit) to be reached. In turn, this allows an estimate to be made of the level and components of the December distributions, using average values. This is set out below.

Pie distributions proj Oct 19 There are significant boundaries of uncertainty around this estimate, and some simplifications. For example, it excludes Ratesetter and smaller individual shareholdings (which represent about 10 per cent of the holdings). It also assumes for simplicity equal ETF payments through the year.

With these caveats and using this approach, the total December distributions are estimated to be around $19 500, out of an annual forecast distributions of $49 800.

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)	110.1%	150.0%
Objective #2 – $1 980 000 (or $83 000 pa)	88.9%	121.1%
Credit card purchases – $73 000 pa	101.1%	137.7%
Total expenses – $89 000 pa	82.9%	112.9%

Summary

Coming events do cast their shadows before them. Even an initial review of progress towards my remaining financial objective has left me with a sense of time foreshortening, and the shadow reaching out towards the present. At some point this shadow will start inevitably and undeniably reaching into and touching my daily life.

At the same time as this sense grows, markets feel delicately poised, with risks of bubbles, and unusual events such as required US Federal Reserve support for the inter-bank market, and a rare failure of a recent tender of short term Australian Treasury notes to reach its target issuance. Despite these types of events and historically low bond rates globally surveyed investor equity expectations remain at elevated levels.

It often pays dividends at times such as this to look to the past. This is an opportunity provided by listening to Yale University’s Robert Shiller in this recent podcast as well as by reading his new work Narrative Economics focused around the historical and continuing role of stories in markets and finance.

Stories – such as a ‘clear’ link between a countries’ economic growth and share market performance – can often be plausible, commonly held, and incorrect. Another informative podcast was an interview with the Head of Product Strategy for Vanguard Australia by Equity Mates. Further interesting insights into the development of modern portfolio theory and efficient markets theory can be accessed in these Youtube videos with interviews of Markowitz and Eugene Fama. The latter makes the point that the growth in indexing is likely to lead to active managers facing higher competition from more skilled investors, as the less skilled depart, making outperformance tougher rather than easier.

This month I was pleased to be mentioned in this short but practical piece on Australian FI seekers, alongside Aussie HIFIRE and Aussie Firebug. For a striking visual tool around planning for FI and safe withdrawal rates, this US-based calculator also occupied some of my time. It gives a unique and simple demonstration of the different probabilities and tradeoffs that can be embedded in reaching FI. Ordinary Dollar here in Australia has some similar calculators. Without seeing coming events, they represent a useful way to look further over the horizon.

Toward Safe Harbours – Exploring the Bond Portfolio

Posted on October 12, 2019January 16, 2022 by The FI Explorer

Neither a borrower nor a lender be.

Shakespeare, Hamlet

Bonds can provide a safe harbour in times of equity market volatility, and be a critical diversifying element in an investment portfolio.

Yet as the journey to financial independence has progressed, one of the least examined parts of the my FIRE portfolio has been the fixed interest and bond components. This is despite the fact they constituted around a quarter of portfolio assets at the start of the journey.

With the end of ‘big rebalance’ into Australian equities at least in sight, keeping to the target asset allocation may require purchasing bonds or fixed interest instruments over the coming year. This would represent the first significant direct purchase of bond assets since 2014. In turn, this means benign neglect of this part of the portfolio is no longer feasible.

To help establish what this potential future purchase should be, it felt critical to know what I had already in the bond part of the portfolio. The target allocation for bonds is currently set at 15 per cent of the total FIRE portfolio.

This longer read article explores these current bond and fixed interest holdings and seeks to reach a possible choice correct for my personal circumstances and goals. Its focus is not offering advice or fully explaining the operation of bonds (pdf), subjects recently (and better) covered by others.

History of bonds in the portfolio

Bonds have formed at least a small part of the portfolio since its inception. From 2009 to 2014 over $130 000 of new investments flowed into bonds through contributions to a number of Vanguard retail funds. This drove the portfolio allocation to bonds to a maximum of 29.5 per cent of total portfolio assets in July 2014.

There was no particularly deliberate logic or consideration behind this increase, in part it probably reflected inertia from having some regular automatic investments in place, and in part, it also likely appeared a relatively safe haven in the immediate aftermath of the Global Financial Crisis.

This lack of active choices around this asset class is also reflected in the short consideration of bonds in annual reviews, where I simply noted that they were included for diversification and to reduce portfolio volatility.

An overall perspective on changes in the absolute level of bond and fixed interest holdings in the portfolio during the past decade is given by the chart below.

Bond - level stacked - Oct 19 In January 2018 bond and fixed interest holdings reached their highest absolute level of $280 000 or 20 per cent of total portfolio assets. In the portfolio review that year I set a bond allocation of 15 per cent – comprising 5 per cent Australian and 10 per cent international bonds, a division not informed by any particularly strong rationale.

A year later I replaced this with a ‘naive diversification’ approach of an equal split of 7.5 per cent each. As of October 2019, bond and fixed interest holdings are around $257 000 or 15 per cent of the total portfolio.

Examining the stores – what lies beneath the current bond holdings

For the journey so far, my knowledge of what was within the bond holdings of the portfolio was limited. From existing worksheets I knew the split between Australian and global bonds, and the absolute level of each. Beyond that was an undiscovered country.

Part of the issue was finding time to delve into what was a relatively small portion of the overall portfolio. Due to holding bonds through no less than four different Vanguard funds, as well as some other smaller fixed interest holdings through Ratesetter peer-to-peer lending and Raiz, establishing full visibility of the holdings was non-trivial.

Yet a rather complicated multi-step Excel sheet did enable a fuller picture to emerge. Each of the Vanguard retail funds actually invests slightly different proportions in just two underlying wholesale funds:

Vanguard Global Aggregate Bond Fund (which is currency hedged); and
Vanguard Australian Fixed Interest Index Fund

Both of these funds invest in a wide range of bonds and fixed interest investments. These include:

Treasury notes and government bonds
Corporate bonds (including financials, industrials and utilities)
Mortgage-backed securities
Government-related entity bonds
Securitised bonds

These are both extremely diversified. Between them they include bond issuances from over 2 200 different issuing entities, and over 8 000 separate holdings (as issuers normally issue bonds regularly, on different terms or for different durations).

Distributions from the bond holdings through the period have been uneven. An example of this can be seen in the distributions from the Vanguard Diversified Bond fund, which saw no new contributions over the past four years.

Despite this stable balance, in this period distributions for this fund have bounced from as low as $140 per year, to a high of $5270. This is likely to be associated with the funds realising substantial capital growth in periods of lower interest rates, and distributing these gains as part of rebalancing to each funds target allocation.

Looking deeper into the holdings – analysing where and what

Once broken into their component parts, analysis of the actual balance of the bond and fixed interests holdings is possible.

The first thing to note is that while to the overall target allocation of 15 per cent has been reached, the balance of holdings is heavily tilted towards international bonds.

Bond - domint - Oct19 This position is inconsistent with my current naive target of evenly splitting domestic and global holdings. This becomes even clearer when the overall breakdown of total holdings is considered below.

Bond all types - Oct19

This shows that global treasury notes, corporate bonds and mortgage backed securities constitute the majority of bond and fixed interest holdings.

By contrast the two largest Australian holdings – government and government-related bonds – represent only around a quarter of the bond and fixed interest portfolio. Ratesetter peer-to-peer lending represents only 7 per cent of total bond and fixed interest holdings, and without specific action this will continue to diminish as the underlying loans are paid back.

It’s important to note that global bond holdings are themselves further diversified across multiple countries, with the largest holdings being exposed to United States, European Union and Japan.

The full split of all holdings can make it difficult to see clearly the relative weights of different types of holdings. The chart below removes the distinction between global and Australian holdings and simply examines the type of bond or fixed interest holding.

Bondfixed - by type - Oct19 Here some observations can be made.

Government or government-related entity debt is the single largest component. Corporate bonds make up just under 20 per cent of holdings, with additional small holdings in mortgage-backed securities and peer-to-peer lending.

The question then looms, is this the right mixture of holdings, and how would an answer to this be established in current market conditions?

I have never been able to get this business of loans and interest into my head. I have never been able to understand it.

Philip II of Spain to his Minister of Finance, 1580

Becalmed – buying and holding bonds in a ‘zero rate’ world

If reaching the portfolio target asset allocation requires a purchase of bonds in the near term, in many ways this will be a difficult move to rationalise and execute.

There is a plausible case that Australia and the world are at the end of a four decade secular bull market – or even bubble – in bonds. Since the early 1980s across most developed markets bond yields have fallen to historically low levels.

Significant portions of government bonds around the world, and even some corporate bonds, are currently trading at negative yields. That is, borrowers are paying for the privilege of loaning their money out to debtors. One day, this extreme and unprecedented global trend could reverse. Bond yields could revert to levels closer to, or even above, their historical average.

There is, however, a significant chance that bond yields seen in the past will not be seen for decades to come. There is also the chance that further falls in yields could occur, leading to further gains in the capital value of bonds. Which of any of these potential futures will play out is difficult to forecast.

Yet this is not the only consideration. The original function of bonds in the portfolio is to reduce volatility, and therefore the primary consideration is not simply their absolute performance, but rather how their returns can be expected to move in relation to other parts of the portfolio.

Traditionally bonds have had low correlations to equity returns, which is a critical consideration given the set 75 per cent target allocation to equities in the portfolio. This has not been uniform, so for example I personally recall 1994 being an exceptional year in which both bonds and equities experienced sharply negative returns. An example of this record can be found in this calendar year return comparison of Australian bonds and equities here (see p.19).

It is possible that this correlation could break down into the future, although there are some underlying drivers for bonds being less volatile than equity, it is perfectly possible for these to be offset by external conditions for prolonged periods.

All bonds are not created equal

It is also worth noting that different types of bonds will have different correlations with risky equities. For example, a government with taxation powers and the option of printing local currency can technically never be forced to default on payments of domestic government bonds, regardless of equity market conditions.

By contrast, although corporate bond holders stand in front of equity holders in the queue for available company cash in difficult times, some of the same market forces could easily be expected to exert themselves on a corporations capacity to pay debt and provide equity returns, giving them higher correlations.

Similar considerations apply to the risk characteristics of peer-to-peer lending – which can often be used for car loans, small renovations or other similar purposes. Risks to repayments of these loans are likely to be significantly correlated to equity market conditions, and to changes in employment and wages conditions. Thus they may produce lower diversification benefits (even where the income is attractive) than traditional bonds.

Flags of convenience – are there benefits in holding offshore bonds?

A major finding from reviewing the detailed holding is the level and breadth of foreign bond exposure. Yet aside from the not insubstantial psychological satisfaction of apparently holding the equivalent around $200 in Romanian or Panamanian bonds, is there actually any financial benefit in holding foreign over domestic bonds?

This question is the focus of an excellent 2018 Vanguard research paper (pdf) Going global with bonds. This analysis uses 30 years of historical data to make observations on the value of global diversification in bonds. It finds that:

Global exposure reduces volatility. Global bonds hedged into the local currency had significantly lower volatility than holding just domestic bonds, across major developed nations including Australia.
In part by reducing individual bond risks. Global bond holdings reduced exposure to local market risk factors and gave better diversification to a range of interest rate and inflation risks that impact bond returns.
Hedging global bonds smooths volatility. Whilst hedged and unhedged global bond returns will be similar over long periods, hedging historically smooths volatility – indeed, significant unexpected falls in the Australian dollar would be needed to mathematically justify not hedging.
And offers more downside protection. Hedged bond portfolios have offered better protection in adverse market conditions than their unhedged equivalents.
Which can help reduce risk even in broad portfolios. Adding hedged global bonds to a mixed equity and bond portfolio can offer some modest portfolio volatility reduction (of around one per cent).

A necessary caveat is that these findings are a function of the time period selected. Yet the analysis is also the best empirical review I have seen so far on the allocation issue which takes into account recent and prevailing bond market conditions.

Departing course – which types of bonds should the portfolio include?

Finally, there is the question of whether the portfolio should seek an alternative exposure to different types of bonds and fixed interest instruments than that currently held. In principle, under modern portfolio theory, there is a specific bond portfolio that would minimise risk and produce an optimal risk-adjusted return for every different equity portfolio and investment target.

Yet having adopted a market capitalisation weighting approach for equities, through equity index ETFs such as Betashares A200 and Vanguard’s Australian equities ETF (VAS), it would not be consistent to start seeking to make active sectoral ‘bets’ in types of bonds and fixed interest. Especially if there was no reason to believe a special insight or information would enable this active approach to reliably add value.

At present, therefore, being ‘market capitalisation weight neutral’ (i.e. holding different bonds in roughly the proportion of their total market value) is a more efficient approach given the low likelihood of outperforming professional bond market participants and higher risks.

At the time of writing, with a gradual reduction in Ratesetter balances expected to continue, the bond portfolio is allocated quite close to global capitalisation weighted benchmarks (i.e. it reflects the size and make up of bond and fixed interest markets globally). This is an automatic result of how Vanguard’s funds themselves generally seek to match Australian and global sector weightings.

Summary – applying the learnings

The exploration of the bond and fixed interest part of the FIRE portfolio has filled in a lot of knowledge gaps that should not have existed. Yet what I have found provides some confidence that thankfully this past neglect has not come at a significant cost or increased risk.

From the review a few useful points and lessons have been reinforced. To summarise:

Reliance on Vanguard retail funds has built the foundations of a diversified portfolio. The bond portfolio is already well-diversified across different bond and fixed interest issuers, markets, countries and risk types.
A ‘home bias’ for Australian bonds and fixed interest is not warranted. Based on the data and analysis above, there is no reason to target a level of Australian bond holdings at anything above around 1.5-2.0 per cent as there are no significant advantages of any ‘home bias’.
Future bond investments will be made through market capitalisation weighted index vehicles. This could plausibly include Vanguard’s Hedged Global Aggregate Bond Index Fund (VGBND) or further investments in Vanguard’s Diversified Bond retail fund.
Peer-to-peer lending should be considered as a separate type of fixed interest asset to traditional bonds and fixed interest. While peer-to-peer lending can have diversification and income benefits, it may not be a direct bond or fixed interest substitute. That is, it may not provide significant reduction in portfolio volatility should loan defaults rise in a downturn.

With these points in mind future decisions on investments in bonds will be made with increased knowledge and taking into account recent market evidence. And, importantly for the decision ahead, the contents of the stores below deck are known and accounted for.

Sources and further reading

Bernstein, W. The Intelligent Asset Allocator, McGraw-Hill, New York, 2000

Graeber, D. Debt: The First 5000 Years, Melville House, 2011

Macdonald, J A Free Nation Deep in Debt, Farrar Strauss and Giroux, New York, 2003

Vanguard Plain Talk Library Bond Investing (pdf)

Vanguard Research Going global with bonds: The benefits of a more global fixed income allocation, April 2018 (pdf)

Disclaimer

This article does not provide advice and is not a recommendation to invest in any specific bond or fixed interest instrument. Its sole purpose is to discuss bond and fixed interest investment issues relevant to my personal circumstances.

Monthly Portfolio Update – September 2019

Posted on October 1, 2019March 24, 2022 by The FI Explorer

We may by care and skill be able to trim our ship, to steer our course, or to keep our reckoning; but we cannot control the winds, or subdue deceitful currents, or prevent disasters.

The Sailors’ Prayer Book: A Manual of Devotion for Sailors at Sea (1852)

This is my thirty-fourth 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 passive 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 per cent, or a nominal return of 7.19 per cent, and are expressed in 2018 dollars.

Portfolio summary

Vanguard Lifestrategy High Growth Fund – $767 282
Vanguard Lifestrategy Growth Fund – $43 936
Vanguard Lifestrategy Balanced Fund – $80 318
Vanguard Diversified Bonds Fund – $109 802
Vanguard Australian Shares ETF (VAS) – $124 643
Vanguard International Shares ETF (VGS) – $24 276
Betashares Australia 200 ETF (A200) – $263 829
Telstra shares (TLS) – $1 870
Insurance Australia Group shares (IAG) – $13 777
NIB Holdings shares (NHF) – $8 760
Gold ETF (GOLD.ASX) – $101 214
Secured physical gold – $16 292
Ratesetter (P2P lending) – $19 140
Bitcoin – $131 280
Raiz app (Aggressive portfolio) – $16 657
Spaceship Voyager app (Index portfolio) – $2 184
BrickX (P2P rental real estate) – $4 402

Total value: $1 729 662 (+$17 325)

Asset allocation

Australian shares – 42.0% (3.0% under)
Global shares – 22.6%
Emerging markets shares – 2.5%
International small companies – 3.2%
Total international shares – 28.3% (1.7% under)
Total shares – 70.3% (4.7% under)
Total property securities – 0.3% (0.3% over)
Australian bonds – 5.0%
International bonds – 10.1%
Total bonds – 15.0%
Gold – 6.8%
Bitcoin – 7.6%
Gold and alternatives – 14.4% (4.4% over)

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

Comments

This month the portfolio grew by just over $17 000 in total, following two consecutive months of small declines. Portfolio level Sep 19 The total equity component of the portfolio has grown, including through new contributions and another part of the June distributions being ‘averaged into’ equity markets. The only major reductions in the portfolio has been the result of a sharp downward movement in the price of Bitcoin.

Monthly change port Sep 19

Lower credit card expenditure and the gradual increase of the trailing three year average of distributions paid has helped sustain a sense of momentum this month. Together they have continued to narrow the gap between distributions paid and credit card spending to less than $500 per month.

Three yr credit card Sept 19 The complete closure of the remaining gap is within sight. Assuming no sustained reversals in the absolute level of distributions through time, this could happen in the next 12 months.

Some added progress towards this goal should come from pending quarterly distributions from the Betashares A200 ETF and Vanguard’s Australian shares ETF (VAS). These are currently being finalised. The draft distributions guidance indicates that for A200 and VAS these quarterly distribution should total around $4 700, approximately double the absolute level of the same quarterly distributions a year ago.

New investments this month have been higher than normal due to a work bonus and the staggered reinvestment of June distributions. They have been directed predominantly to Vanguard’s Australian Shares ETF (VAS) with a small recent allocation to Vanguard’s international shares ETF (VGS). Following the recent fee reduction in VAS, I have directed Australian purchases through to this ETF, preferring the (slightly) wider exposure it delivers through following the ASX300, compared to the Betashares A200’s slightly narrower holdings.

The end of ‘the big rebalance’ into Australian equities

The reason for the split between Australian and international equity purchases is that this month has seen the effective end of ‘the big rebalance’ – that is, the gradual movement to a 60/40 split between Australian and international shares.

This was first targeted in my January 2019 review of portfolio targets and allocations. Previously my Australian and international equity allocation was largely just an unconscious and purely mechanical outcome of the splits in various Vanguard retail funds, and a number of smaller side Australian shareholdings.

The last nine months – by contrast – has seen a concentrated direction of new funds and distributions into Australian shares to achieve the targeted balance. The shift has been significant, with the value of Australian shares only overtaking international holdings in the second half of 2018. International shares have fallen from more than a third of total portfolio assets at this start of this record to closer to a quarter. Port bar Sept At the same time Australian equities now make up 42 per cent of total portfolio, and have just reached 60 per cent of the equity portfolio. All this has occurred as the total equity portfolio has grown from $630 000 at the start of this journey, to over $1.2 million this month. Changes port two bars The main vehicles for this expansion over the past two years has been Betashares A200 and Vanguard’s VAS ETFs. More recently, as mentioned, I have added Vanguard’s global share ETF (VGS) to allow an avenue to keep within the targeted split with future contributions.

Measuring investment income from tax returns

This month also saw completion of my tax return, including explaining my tax position to a brand new tax agent. The tax assessment from this past financial year provides an additional data point about the taxable investment income being generated by the portfolio.

The graph set out below updates the series published last year on taxable investment income. It is taken from the return items for partnerships and trusts, foreign source income and franking credits (i.e. items 13, 20 and 24 on the return, and not including capital gains) over the past nine years. Sept 19 Tax Level This shows that taxable investment income has risen only around five per cent over the past financial year. This likely reflects the decline in higher interest payments from a slow rebalance away from Ratesetter towards equities. Taxable investment income is still well short of both the original objective, and even further short of Objective #2. Sept Tax 19 - 9yr

As previously outlined, there are a range of factors that likely account for the mismatch between tax return income and received distributions. These could include timing differences, capital gains realisations, and potentially even small errors in how I have added in individual return items in past years. I have also continued to seek to avoid double counting and so understatement is also a possibility, given the formats and labelling of tax returns are not always particularly clear.

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)	108.2%	147.5%
Objective #2 – $1 980 000 (or $83 000 pa)	87.4%	119.1%
Credit card purchases – $73 000 pa	99.3%	135.4%
Total expenses – $89 000 pa	81.5%	111.1%

Summary

Forward progress has resumed, with the growing warmth and life of spring. The last few months has been a continual reminder that the fickle direction of market winds may play a greater role than sheer saving and investing efforts at this point in the journey. Focusing on the process, rather than the short-term outcome is therefore almost forced upon one – which perhaps is no bad thing after all. Indeed, increasingly I have wondered whether these now ingrained habits and processes will themselves be difficult to break out of, even as I definitively pass some FI benchmarks in future months and years

The varying winds will also increasingly dictate where additional contributions are to be made. This is the automatic result of targeting an asset allocation with new contributions rather than active rebalancing through selling existing holdings. In fact, it probably constitutes one of the more difficult tests for a chosen risk allocation, as it will tend to result in buying unspectacular portfolio ‘laggards’, rather than assets that have recently moved up, without the consolation of taking these new funds from locked in profits elsewhere in the portfolio. This can lead to signals that are easier to follow in theory than in practice.

As an example, currently Australian government bond yields are close to historical lows, and potentially heading lower. This is highly relevant to FI planning, as there is some academic evidence that the ‘four percent rule’ has a higher failure rate in low bond rate environments.

There is also a strong possibility that bonds are close to the end of a forty year decline in yield – and have nowhere to go. The increasing spread of negative yielding government and corporate bonds around the world, however, also holds out equally plausible but very different possibilities, at least in the short term.

This is more than a hypothetical issue and uncertainty. Through the next 12 months it is possible that my target asset allocation will start signalling a need to buy bonds. This would involve a need to find the right investment vehicle to access this asset at least cost.

On the same topic, this month saw an excellent explainer piece from Aussie HiFIRE on bonds, and also a good discussion from Kurt at Pearler on how to put the modern portfolio theory to practical work in FI portfolio design. Youtube content on FI and portfolio issues seems to be improving all the time as well, including this short video on thinking about the role and value of dividends.

All such guidance represents a way of keeping a reckoning on the unfolding horizon, its dangers and subtle deceits.

Monthly Portfolio Update – August 2019

Posted on September 1, 2019March 24, 2022 by The FI Explorer

It is idle, having planted an acorn in the morning, to expect that afternoon to sit in the shade of the oak.

Antoine de Saint-Exupéry, Wind, Sand and Stars

This is my thirty-third 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 passive 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 – $750 246
Vanguard Lifestrategy Growth Fund – $43 194
Vanguard Lifestrategy Balanced Fund – $79 500
Vanguard Diversified Bonds Fund – $110 418
Vanguard Australian Shares ETF (VAS) – $102 977
Vanguard International Shares ETF (VGS) – $20 184
Betashares Australia 200 ETF (A200) – $258 984
Telstra shares (TLS) – $1 982
Insurance Australia Group shares (IAG) – $14 056
NIB Holdings shares (NHF) – $8 868
Gold ETF (GOLD.ASX) – $104 149
Secured physical gold – $16 759
Ratesetter (P2P lending) – $19 968
Bitcoin – $158 330
Raiz app (Aggressive portfolio) – $16 223
Spaceship Voyager app (Index portfolio) – $2 104
BrickX (P2P rental real estate) – $4 395

Total value: $1 712 337 (-$2 653)

Asset allocation

Australian shares – 40.5% (4.5% under)
Global shares – 22.2%
Emerging markets shares – 2.4%
International small companies – 3.1%
Total international shares – 27.7% (2.3% under)
Total shares – 68.3% (6.7% under)
Total property securities – 0.3% (0.3% over)
Australian bonds – 5.1%
International bonds – 10.1%
Total bonds – 15.1% (0.1% over)
Gold – 7.1%
Bitcoin – 9.2%
Gold and alternatives – 16.3% (6.3% over)

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

Comments

The portfolio experienced a small decline this month, with an overall decrease of $2 600. This movement comes after a strong period of expansion through the first half of the year in the value of the portfolio. Pie progress Aug 19

As with last month, the fall occurs despite some significant new investments being made, meaning the absolute size of the decline is somewhat obscured. Renewed concerns about global trade and a relative weakening in the outlook for future earnings played a significant role in the overall movement of the portfolio. Monthly chng - Aug 19 Once again movements this month within the portfolio have been relatively limited in terms of the size of the portfolio.

Equity holdings have declined by around $28 000 when contributions are accounted for, whilst appreciation in the price of gold has offset just over a third of that loss. In fact, despite no recent purchases, the gold component of the portfolio is currently at the highest nominal value it has ever held. On the topic of gold, this 2013 paper (pdf) provides a comprehensive and skeptical empirical analysis of the range of claims made to support holding gold, including tracing the real gold value of average soldiers pay across 2000 years.

This month has seen a continuing ‘averaging in’ of the capital from July distributions. These have been directed to purchases of Vanguard’s Australian shares ETF (VAS). This is to bring the allocation closer to my original targets – with my Australian shares allocation currently further underweight than the international shares allocation. Psychologically, a weakening Australian dollar has also made purchasing unhedged international shares more problematic.

Risk, volatility, markets and economies

There has been significant market volatility this month, and discussion around the future of Australian and global growth in the midst of trade tensions between US and China.

In such times, something to remember as this St Louis Federal Reserve piece points out, is that the economy and sharemarket are not the same thing. This means that bad (or good) news for one, does not necessarily imply anything about the other. Missing this has the potential to lead to overconfident investment actions predicated on assumptions of future national economic trends (which will themselves most likely be priced into equity markets well before any retail investor reading the news arrives).

The volatility in equity markets has brought out many well-intentioned injunctions to remain calm and fixed on the objective of contributing capital with a long-term view in mind.

At times, however, this wise advice can shade into a form of near complacency – for example, for people to invest confident in the knowledge that long-term returns are (almost) guaranteed. No doubt this is generally good advice, directed at easing particularly new investors’ concerns about investing at the “wrong” time, and reducing the potential damage from selling into falling markets due to panic.

Even as I continue to invest amidst volatility, it is important to reflect on Elroy Dimson’s definition that ‘risk means more things can happen than will happen’, and to consider that the history of equity markets available to us provides only a basis for sound conclusions around what has happened, not what could happen. This is the definition of the risk assumed in markets by investors.

None of this is to suggest that starting, saving and regular investing with a view to one’s individual risk tolerances are not the most important steps in the path to FI. There is a need to pause, however, and acknowledge that at times common financial independence investment precepts bear a disconcerting passing resemblance to the declaration and mathematical proof offered by famous stock promoter Jacob J Raskob in the well-known Ladies Home Journal (pdf) article exactly 90 years ago. This declaration was that with a steady investment in equities, based on the past patterns of returns, ‘everybody ought to be rich’.

Nearly 90 years happened to be just before the Great Depression devastated equity markets and employment prospects alike, and US equity investors were behind in nominal terms for around 25 years. Interestingly, however, this New York Times article argues that deflation, higher dividend yields and impacts from changes in the Dow index composition could theoretically have shortened the real losses of any investor to just 4.5 years, provided they possessed the resources and fortitude to hold on to average stocks.

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)	107.1%	145.4%
Objective #2 – $1 980 000 (or $83 000 pa)	86.5%	117.4%
Credit card purchases – $73 000 pa	98.3%	133.4%
Total expenses – $89 000 pa	80.7%	109.4%

Summary

Progress against my goals and benchmarks has been static this month, with the exception of the ‘total expenditure’ benchmark. My detailed review of expenditure last month identified that I could lower this to recognise some double-counting of fixed expenses, and this has meant a leap forward in progress in that aim of 5.8 per cent. This moves the clock forward appreciably for achieving that benchmark.

As a general rule, it is always later than we think. For example, on a recent lunch time walk it occurred to me that if my progress to my current FI target of $1.98 million is considered in terms of the length of an ordinary working day, it is currently approximately 3.50pm in the afternoon. Quite late, and just over an hour until heading home.

This perspective, of being further towards the tail end than expected, is explored fully and powerfully in the blog Wait but Why here. It helps frame the remaining journey. Viewed in this way, wishing time away seems less useful and fitting than seeking to fill the remaining time with as much meaning, learning, knowledge transmission and patience as feasible. Yet it also explains why in a FI context at this stage sharp changes in investing approach, or commencing new ‘side hustles’ have limited appeal.

Despite it being late afternoon from this one perspective, there are a couple of other considerations or viewpoints. One is the potentially deceptive role of compounding later in the journey, which means that – at least in a stylised world of ‘smooth returns’ – the end goal is actually likely closer than any purely linear measure would suggest.

The other counterpoint to this is that while in my case the absolute journey to FI has involved serious investments over around 18 years, this is not the whole story. Viewed in terms of the average ‘age’ of dollars actually contributed or invested, the journey of the average dollar in the portfolio has been shorter.

In fact, in terms of dollars contributed, around 50 per cent have been contributed since January 2016. So, in some ways, it is more akin to mid-morning for the portfolio as a whole, meaning perhaps that I should not reasonably expect to shade myself under the oak tree just yet.

Finally, this month also saw Pat the Shuffler emerge from a short hiatus and provide a honest and well-argued insight into his rethink on investment options between LICs and ETFs. I also enjoyed reading the start of another Australian FI voice at Fire for One.

The past few months has also had many interesting podcasts related to FI – from The Escape Artists’ Chris Reining on Equity Mates, to a really fascinating practical ChooseFI episode on David Sawyer’s on the UK Path to FI. On the slightly more technical and future focused side of finance, the outgoing address of the Bank of England’s Governor to the Jackson Hole central bankers gathering provides much food for thought on current and longer term monetary and currency issues, particularly as global bond rates continue to cross the ‘zero-bound’ into uncharted territory.