In order to arrive at what you do not know

You must go by a way which is the way of ignorance.

T. S. Eliot, Four Quartets – East Coker

Year in Review

The year past has been extraordinary in so many ways, entirely separate from the progress to the goal of financial independence.

Part of the structure of the year has been seeing elements of this new reality bleed into markets and economic developments, affecting the portfolio in profound ways.

At the the broadest level, the year saw the passing of my portfolio objective, in a rapid unexpected way in December. In fact, as can be seen below, this year saw the crossing of the last two outstanding portfolio measures.

Progress against FI measures through 2020

Measure	Portfolio	All Assets
Portfolio objective – $2,180,000 (or $87,000 pa)	82%→104%	112%→136%
Credit card purchases – $71,000 pa	100%→127%	136%→166%
Total expenses – $89,000 pa	80%→102%	109%→133%

On an ‘All Assets’ basis – taking into account superannuation assets – the year saw further progress, to be well above the minimum levels required to sustain the portfolio income objective.

Course of the voyage

The progress of the year was steeped in volatility. This year saw the largest ever fall in the value of the portfolio, and also two of the largest ever monthly gains.

This volatility is clearly evidenced in the variations in the total end of month portfolio values in the chart below.

Overall the portfolio increased by over $500,000 through the full year. This is the largest rise in the value of the portfolio over a single year on record.

Quite simply, it has moved the portfolio to a different magnitude and scale of operation. The chart below of the overall value of the portfolio on a calendar year basis illustrates this alteration starkly.

It cannot be escaped that the largest single contributor to the increase over this year was a surge in the price of Bitcoin, leading to over $300,000 of the gains.

Equity markets, however, also pushed forward in the second half of the year, and the equity portfolio finished around $175,000 higher than the beginning of the year. The gold component of the portfolio also ended the year higher.

As the set out in the In Way of Harbour post two weeks ago, combined this progress resulted in the passing of the portfolio objective in mid-December.

Direction of portfolio contributions

This year portfolio contributions were directed to only two significant investments – the Vanguard exchange traded funds for Australian shares (VAS) and global shares (VGS).

This contrasts with the generally splintered nature of investments over the previous course of the journey, in which it was not unusual for more than four or five different vehicles to receive contributions. This can be seen by the chart below.

The split in contributions for this year reflected a dynamic asset allocation approach. Each fortnight, an updated excel spreadsheet helps show which component of the portfolio is lagging furthest below its target allocation. New investments are directed to this asset class.

A true and steady course pursued

This year has been an important one for the financial independence journey. In fact, arguably the most important.

Yet the journey this year has featured fewer adjustments and changes than any previously. Rather it has been a year of fairly steady mechanical actions, taken in pursuit of the overall portfolio plan.

As the journey has proceeded towards its destination, it has been a strength to have a simple approach of just investing twice per month in the asset class furthest from its target, and to pursue a pre-set allocation between Australian and international equities. As my examination of the equity portfolio found, this ensures investments are spread across nearly 6,000 different equity securities.

So to some extent, there has been an achievement of simply staying the course – and calmly implementing the plan, even as conditions through the year imposed the largest dollar losses the portfolio has ever seen.

Yet the recent recovery should not necessarily be seen as a ‘payoff’ or reward for this steady application. Markets might just as well have continued to fall. To look for patterns of justice or morality in market events is to make a fundamental category error, and any that do so should perhaps aim to read a well-chosen book instead.

Progress of the record

The year has also been a successful one for this record itself, the blog. Over the course of the year there has been 60,000 page views based on WordPress data, with monthly page views averaging around 5,000.

This is a modest size in Australian blogging, and indeed Australian FI blogging terms. Yet using sessions and session times can help put this into a more tangible perspective.

The time spent by visitors on the site is equivalent to one person sitting and continuously reading the blog for around eight months of standard working hours. Viewed in this way, such a dedicated reader obviously deserves considerable respect, and the best experience that can be provided.

Towards the horizon – future plans and goals

Over past weeks, as is my habit each year during this holiday break, I have been reviewing my investment policy and looking at possible new goals.

This has obviously been an especially salient exercise since the middle of this month. It has involved thinking carefully through and testing my plans, assumptions and potential asset allocation approaches.

A final jigsaw puzzle piece in this respect are distributions from funds and exchange traded funds. So, as previously, before finalising any new plans or approaches in a new post, I want to fit this missing piece into the picture. Unfortunately this entails waiting until all December distributions are finalised or announced. This will also lead into a regular portfolio income update.

I am looking forward to sharing these updated plans – including possibly new portfolio objectives – in the next week or so.

If you are a boat that wants to sail in windy weather, you must be more stubborn than the waves.

Mehmet Murat ildan

Monthly Portfolio Update – December 2020

This is my forty-ninth monthly portfolio update. I complete this regular update to check progress against my goal.

Portfolio goal

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

This portfolio objective is based on an expected average real return of 3.99 per cent, or a nominal return of 6.49 per cent.

Portfolio summary

Vanguard Lifestrategy High Growth Fund	$795,506
Vanguard Lifestrategy Growth Fund	$44,605
Vanguard Lifestrategy Balanced Fund	$82,652
Vanguard Diversified Bonds Fund	$109,841
Vanguard Australian Shares ETF (VAS)	$267,825
Vanguard International Shares ETF (VGS)	$107,732
Betashares Australia 200 ETF (A200)	$259,920
Telstra shares (TLS)	$1,599
Insurance Australia Group shares (IAG)	$5,980
NIB Holdings shares (NHF)	$7,212
Gold ETF (GOLD.ASX)	$111,964
Secured physical gold	$17,947
Ratesetter (P2P lending)	$6,218
Bitcoin	$420,440
Raiz app (Aggressive portfolio)	$19,008
Spaceship Voyager app (Index portfolio)	$3,081
BrickX (P2P rental real estate)	$4,500
Total portfolio value	$2,266,030 (+$180,228)

Asset allocation

Australian shares	38.7%
Global shares	21.3%
Emerging market shares	1.9%
International small companies	2.4%
Total international shares	25.7%
Total shares	64.4% (-10.6%)
Total property securities	0.2% (+0.2%)
Australian bonds	3.6%
International bonds	7.5%
Total bonds	11.1% (-3.9%)
Gold	5.7%
Bitcoin	18.6%
Gold and alternatives	24.3% (+14.3%)

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

Comments

This month has seen the second largest increase the portfolio in this four year record, immediately following the record growth in November.

The overall portfolio has increased by over $180,000, resulting in the meeting of the portfolio objective around half way through December, and notionally six months ahead of schedule. The portfolio grew 8.6 per cent over the month.

This growth has almost exclusively arisen from the substantial rise in the price of Bitcoin, with the holding increasing in value by around 50 per cent this month alone. Since March of this year, the value of these holdings have more than tripled. Compared to this, equities have generally been steady and unexceptional.

The advance in the value of Bitcoin has continued against the backdrop of continued monetary base expansion, trial adoption of it as a corporate treasury reserve by US business intelligence firm Microstrategy, and the continuing disappearance of yields on fixed interest securities. Some US financial commentators are even starting to discuss their experiments in ownership, while others remain highly skeptical.

The fixed interest components of the portfolio have remained stable, while the value of gold holdings has risen slightly.

This month also saw some other financial developments.

Neo-bank Xinja, in which I had around $50,000 of cash invested promptly notified account holders that it was shutting down. Media reports discussed the fall of the venture, but it was the only experience I have ever had of a bank actively shutting down, and inviting depositors to take their money elsewhere.

As a process, however, it was quite smooth, with Xinja obviously finding the business model of paying out relatively high introductory rates in a period of close to zero nominal rates increasingly difficult over time.

Additionally, this month I paused regular contributions to the Spaceship voyager app on the basis of focusing investments towards the major ETFs, and creating the flexibility in the future to sell or re-allocate these assets later, without any unnecessary realisations of capital gains.

Sailing out of trim revisited

Last month I entertained the twin questions: would crossing the portfolio objective ‘finishing line’ with an asset allocation quite different to the target allocation be a matter of little or great concern? And is it actually realistic to seek to avoid it?

The progress of the last month has been breathtaking, and forced such questions out of the realm of the hypothetical, to be active issues of consideration in my upcoming investment policy review.

The chart below sets out the annual portfolio asset allocation over the past 13 years.

What can be seen is that the rise of Bitcoin as part of the portfolio has as a arithmetic consequence lowered the asset allocation of equities. The same phenomenon occurred in January 2018, at a previous high. In pure equity allocation terms, therefore the portfolio enters this year less exposed to equity markets than at any time over the past three years.

This might in some ways be viewed as a relatively ‘defensive’ positioning, at least in the sense that around 35 per cent of assets are exposed to non-equity market factors. Yet it is worth looking below the surface, and testing this.

In fact, for much of this year the correlation between Bitcoin and Australian share holdings has been relatively high – around 0.6 for the second half of the year. In other words, Bitcoin has tended to rise and fall with Australian shares rather than moving in the opposite direction. By contrast, gold has acted more in line with its usual role, with a negative correlation to shares.

Recent movements have left the absolute level of portfolio variance at all time highs. Here – set out in the chart below – the measure is the summed absolute value of all variances between target and actual allocation percentages.

From a range of 5 to 15 per cent since early 2019 it has moved above 25 per cent.

To put this in context, portfolio variance in percentage terms now sits at levels last experienced in 2013-2016, a period in which fixed interest returns and some inattention had led to much higher bond allocations than ultimately sought. In absolute dollar terms, variances have broken decisively higher, exceeding $600,000 this month, from levels of around $100,000 to $200,000 over the past two years.

This month seeking to lean against these variances led to continued purchases of Vanguard exchange traded funds, with units bought in the international shares ETF (VGS).

Trends in average credit card expenses

Trends in credit card expenditures remain little changed, noting that figures next month will reflect higher expenditure over the Christmas break period.

Consistent with recent months, however, average monthly expenditure on credit cards has continued to fall. As can be seen, the moving average level of distributions since the beginning of this record is also currently declining, reflecting some larger one-off distribution payments in the data sample being excluded over time.

When the more variable monthly estimates are examined below, total expenditure continues to track at levels just above estimated distributions, while credit card expenses remain comfortably met.

Both of the charts above are likely to shift slightly as assumptions around distributions over the July to December period are replaced by actual distributions. To the extent that these have fallen below projections, progress will look a little worse, though the impact on the first chart is likely to be marginal.

Progress

Measure	Portfolio	All Assets
Portfolio objective – $2,180,000 (or $87,000 pa)	103.9%	135.8%
Credit card purchases – $71,000 pa	126.8%	165.8%
Total expenses – $89,000 pa	101.6%	132.8%

Summary

The year opened with some idle musings on the ‘what if’ scenarios of mild or serious equity market falls. In March, these scenarios were effectively tested and played out on the portfolio. Similarly the last few months have seen some early thinking on the then scenario of unexpected Bitcoin gains pushing the portfolio over the finish line.

That record does not so much increase my confidence in predictions as suggest caution about any next speculation on what the next month or year might hold.

Perhaps on a psychological level markets seem especially delicately poised at rich valuations, just because the portfolio has just recently passed its target goal. Certainly there is some evidence that the equity risk premium – the expected equity return over risk-free bonds – remains stubbornly high, and with a lower dispersion than normal around various (imperfect) estimation approaches.

Meanwhile, as portfolio distributions for the second half of the year are finalised, there is some interesting indications from both forecast Vanguard international share ETF distributions and other evidence that dividends from the US – for the moment – have been less affected than dividends from elsewhere by the economic impacts of COVID-19 and lockdowns.

This month I have been reading a biography of famed stock speculator, financier and US presidential counsellor Bernard Baruch. Along the same lines, I have also spent much time listening to Joseph Noel Walker’s brilliant podcast interviews with economists Vernon Smith and Ed Glaeser on bubbles and gambling respectively.

Such readings and podcasts are perhaps an attempt to prepare for windy weather ahead. To reinforce the stubborn efforts made through this year to reach the financial independence goal now passed. As the new year begins, my attention turns to new plans and objectives, with greater humility around the capacity of any plan to define the progress of this stage of the voyage.