Because things are the way they are, they will not stay the way they are.

Berthold Brecht

Twice a year I prepare a summary of total income from my portfolio. This is my tenth portfolio income update since starting this record. As part of the transparency and accountability of this journey, I regularly report this income.

My goal is to build up a portfolio capable of providing a passive income of around $90,500 by July 2022 (Portfolio Goal).

Portfolio income summary

Investment	Amount
Vanguard Lifestrategy High Growth (retail fund)	$66,713
Vanguard Lifestrategy Growth (retail fund)	$3,627
Vanguard Lifestrategy Balanced (retail fund)	$5,758
Vanguard Diversified Bonds (retail fund)	$5,909
Vanguard Australian Shares ETF (VAS)	$4,645
Vanguard International Shares ETF (VGS)	$2,024
Betashares Australia 200 ETF (A200)	$3,394
Telstra shares (TLS.ASX)	$43
Insurance Australia Group shares (IAG.ASX)	$89
NIB Holding shares (NHF.ASX)	$120
Plenti/Ratesetter (P2P lending) (estimated)	$150
Raiz app (Aggressive portfolio)	$210
Spaceship Voyager app (Index portfolio)	$0
BrickX (P2P rental real estate)	$42
Total Portfolio Income – Half-Year to June 30, 2021	$92,724

The chart below sets out the income or distributions received on a half-yearly basis from the financial independence portfolio over the past five and a half years.

The following pie chart is a breakdown of the percentage contribution of each major investment in the portfolio to the total half-yearly distributions.

Comments

The total distributions from the portfolio over this half-year was $92,724, or the equivalent of $15,400 per month over the past six months.

This is an unprecedentedly high set of portfolio distributions. It is nearly double the previous highest distributions of any June half-year period.

The distributions exceeded my best forecasts by a substantial margin. They simply look, at first glance, different in kind to any past set of June distributions. In fact, I spent several days confirming by different means their level, to be sure that a mathematical error had not been made.

In the May portfolio update an estimate using median payouts for the exchange traded funds, and the past five years of average Vanguard retail funds led to a forecast of around $52,000 for the half-year period. This forecast took into account the actual March quarter payout of $10,000 and projected June quarter payouts of around $42,000.

This once again demonstrates the unreliability of most forecasting approaches over a single year. It is also not the first time that distributions have surprised significantly to the upside.

One of the facts that is interesting for context of these results is that although the absolute amount of increase in this June payout is unprecedented, of itself a doubling of June half-year income from one to the next year is not. The same occurred in June 2017, and a near doubling of previous results also took place in June 2016.

Assessing the contribution of June quarter results to half-year outcome

These portfolio income updates have typically a half-year focus, historically aligning to major distribution payout schedules of the Vanguard retail funds that formed the majority of the portfolio.

Over time, however, a growing exposure to exchange traded funds with quarterly payouts has led to more documenting of quarterly data, including for the purposes of (imperfectly) seeking to project future portfolio income.

This more detailed analysis is quite useful in the current case, because it helps illustrate that the half-year income is the principally the result of a two factors – a high one-off Vanguard Diversified Bond fund distribution in the first quarter, matched with an unusually high distribution from the Vanguard High Growth retail fund this past quarter.

This latter factor is evident from the chart below comparing June quarters over the past five years.

Together these two events caused portfolio income in the last financial year to slightly exceed my target portfolio income of $90,500 per year.

Long-term trends in levels of portfolio income: 1999-2021

The close of the financial year provides an opportunity to set the recent distributions in the context of a longer-time series of portfolio income measured over the financial independence journey to date.

The past financial year distributions were $135,936 or around $11,300 per month. This is nearly double the portfolio income of the next higher financial year (of 2017-18).

The chart below provides an updated history of total portfolio distributions in nominal dollars, with the green bars indicating the period covered by this record.

The average portfolio level through the relevant financial year is also given (see red dotted line).

This chart shows quite clearly that:

• The level of distributions is generally linked to portfolio size, but with some marked deviations – Generally portfolio size is the obvious primary driver of the absolute level of distributions, but there are periods of significant divergence where the relationship is weaker and looser (with the two years from July 2018 to July 2020 being examples)
• Compounding effects in the latter part of the journey are strong – In fact, the line of best fit for both the total level of distributions and the portfolio itself is an exponential function.

For simplicity the graph above tracks nominal dollars and so mildly overstates the ‘real’ value of recent distributions and portfolio values compared to earlier values. This has the effect of slightly exaggerating the relative significance of recent progress.

Even so, this is only a marginal effect compared to the dominating compounding process at work. For example, even calculated in real constant 2019 dollars, over half of total portfolio income has been generated in just the past four financial years. In nominal dollar terms, over three-quarters of total portfolio income has come in the last eight years.

In a portfolio income update a year ago I observed that the past four years appeared to have established a new normal operating range for portfolio distributions, with most observations falling within the range of $50,000 to $70,000. This finding appears to be weakened by the past financial year results.

The question is the extent to which this much higher level recorded is a temporary outlier, compared to past results. It’s a question that might become clearer looking at the composition of the distributions and the distribution rate of the portfolio.

Composition of the portfolio distributions: reversing course

Since around June 2018 all new investments have been made in n exchange traded funds – specifically, A200, VAS and, more recently, VGS. Over time this was expected to mean that their distributions would gradually rise in relative terms, compared to the legacy Vanguard retail funds that constituted almost the entirety of the earlier FIRE portfolio.

This process was slowly proceeding from mid-2018, and non-Vanguard distributions even made up the majority of distributions in the second half of 2019. Yet since that time there has been a strong reversal.

This half-year, consistent with the past 18 months, distributions from the Vanguard Diversified High Growth retail fund have once again become the key driver of the level of payments.

This can be be seen in this chart below, which sets out the level of, and changes in, major components of portfolio distributions over the past two decades. The extraordinarily strong distributions have led to a need to change the scale of the axis.

As with previous periods, the single largest contribution to sustained high distributions is the distribution from the Vanguard High Growth fund (teal), which has skyrocketed to around double the previous highest level.

Changing the axis to recognise this strong performance has had the unfortunate effect of making the continued modest and uneven growth of distributions from both the VAS (purple) and A200 (blue) exchange traded funds from June 2018 onwards look relatively insignificant by comparison.

The three exchange traded funds (VAS, VGS and A200) have generally produced distributions at, or just below, their average levels over the past half-year. In contrast, the three out of the four legacy retail Vanguard funds experienced distributions at the highest level ever recorded, as can also be seen from the chart below.

The results this half-year also clearly continue the trend for increasing end of financial year payment, year over year. This means that if future distributions are estimated on the median or average of past ‘cents per unit’ payouts over the longer-term they will systematically under-estimate payments.

As an example, a projection of total annual distributions without accounting for this effect, at the current portfolio level, is around $64,000. The same estimate, using instead the last five years of payout levels for the Vanguard funds, produces an annual projection of distributions of more than $90,000.

Vanguard retail funds have again collectively made up more than 90 per cent of total half-year distributions. Part of the reason for these high payments are likely to be found in fund rebalancing, redemptions and associated realisations of capital gains within the Vanguard retail funds.

For a point of comparison against these half-year results (above), the composition of the financial year 2020-21 distributions is set out in the chart below.

As can be seen, on an annual basis the new sources of distributions – exchange traded funds – make up only around 13 per cent of total annual distributions, as the Vanguard distributions once again take centre stage.

Comparing the average rate of distributions over time

The overall portfolio distribution rate for this calendar year is 6.0 per cent. This rate is estimated as annual paid out distributions as a simple percentage of the average total portfolio value over the year.

This measure allows a different view of the annual income performance of the portfolio which better accounts for the growing size of the portfolio.

The figure of 6.0 per cent for this past financial year is high when compared to the average rates recorded over time, being the fifth highest figure recorded in the past 22 years of investing. It is especially high considering that the average level of the portfolio includes bitcoin, which does not produce any income by definition.

The median distribution rate over the period 1999 to 2021 remains at 4.4 per cent.

Comparing average portfolio distributions and expenses

A commonly used indicator for whether financial independence has been achieved is the level of portfolio investment income compared to expenses. For some time each monthly update in this record has tracked the extent to which actual paid out distributions are able to meet either total monthly expenses, or credit card expenses.

The chart below sets out the proportion of estimated total expenses (credit card expenses plus estimated additional annual fixed expenses) that are met by portfolio distributions.

To reduce the volatility of month-to-month results, rolling three-year averages of both distributions and expenses are used in the chart.

As this record began, around 33 per cent of total annual expenses were met by portfolio distributions. This rose to 65 per cent by June 2018, and then increased, but at a slower pace, to around 80 per cent in June 2020.

At the beginning of this year around 90 per cent of total expenses were met by the portfolio, and between March and April this year the 100 per cent threshold was reached and exceeded.

The progress over the past two years has resulted from the twin effects of a continued reduction in monthly expenses, and a growth in portfolio distributions.

The record high distributions this half-year has also significantly shifted the overall picture of progress towards distributions meeting my ‘credit card FI’ goal. This is shown in the following chart.

This takes a three-year moving average of both distributions and credit card expenses up to the end of June.

Past versions of this graph in regular Monthly Portfolio Updates tended to show distributions and card expenses touching, and then appearing to decline together.

When the same graph is recalculated using the latest higher than forecast distributions, replacing previous placeholder average estimates, it is reinforced that a definite ‘crossing’ event has occurred. From around June or July of 2020 credit card expenses continued to sink lower, while distributions climbed past them.

This means that the portfolio now more than pays for every item typically bought on my credit card in day-to-day life, and also meets a rolling total of total average expenses over the past three years.

Allocating the funds from portfolio distributions

The substantial June distributions provide the flexibility to do a few different things over the next half-year.

Between the distributions of the Vanguard funds, and exchange traded funds A200, VAS and VGS around $82,000 of capital will available to be invested or allocated over the next few weeks.

This sum is less than the half-year total reported above because April quarter distributions from a number of the funds and ETFs have already been paid and were immediately re-invested in May.

Consistent with with past practice I will put aside a quarter of the payments (around $20,000) in a dedicated online sub-account to meet future portfolio-related tax liabilities.

In January I also made a symbolic small start of funding a ‘freedom’ themed cash sub-account, to build towards my target of having one full year of cash set aside by July 2022. I intend to add further to this from these distributions, with the current intention being to increase this fund by a further $4,000.

My current plan is to reinvest the remaining $57,000 in equal increments on a fortnight basis though July to December. These additional re-investments will be directed according to my asset allocation plan, targeting whichever asset class is furthest from its percentage target allocation in each particular month.

As discussed last month, however, this is not likely to include any additional bond purchases, due to the particular outlook and monetary policy conditions impacting yields in that sector.

Following my decision in the annual portfolio review to target over the medium-term an equal equity exposure to global and Australian shares, this is likely to mean continued future investments in both the Vanguard international shares ETF (VGS) and its Australian equity-focused equivalent (VAS). The relative required magnitudes of these investments will depend on future market movements in these markets, taking into account the long-term nature of the target.

Reviewing and redeploying the emergency fund

A further regular step following finalising the level of half-year distributions is to review the level of my emergency fund.

This fund is set at a level of providing the equivalent of one year of expenses equal to my Portfolio Goal target income of $90,500. It is primarily designed to cover expenses in any unexpected periods without employment income.

The June half-year distributions takes the raw five-year average of annual distributions to nearly $79,000. I have also reviewed alternate estimates based on average per fund or ETF unit distributions and long-term estimates of total distributions as a percentage of the portfolio. These two approaches suggested likely forward distributions between $64,000 and $66,000 per year.

An average of all of these approaches suggests likely future distributions of around $70,000 per year.

In recognition of this I will be further reducing my emergency fund from $30,000 to $21,000 and likely shifting this excess cash amount over to the symbolic ‘freedom’ sub-account mentioned above.

Although a notional shift from cash to cash, nonetheless, this movement is in part a recognition of the transition from protecting against emergencies in one state – while working – to having a substantial cash buffer in another state – financial freedom.

Observations

The June half-year distributions have again, as with the previous December distributions, been much higher than expected. The result is more than double the cautious long-term average estimates based on available records of past payouts.

A significant factor in play is likely to be the realisation and distribution of capital gains in the diversified Vanguard High Growth retail fund. Continued investment since 2018 in exchange traded funds, and their growing size led me to underestimate the potential for this feature of the Vanguard retail fund to re-assert itself so firmly.

Over time, I had expected lower volatility in the distributions record, from the sector-based exchange traded funds having fewer reasons to distribute capital gains to unit holders.

Receiving the equivalent of my portfolio target income in just a half-year period is a demonstration of this volatility. At present, my assumption is that this high set of distributions is an outlier, and not a harbinger or indicator a new level of average distributions. Further COVID-19 lockdowns or other economic challenges could easily lead to substantially lower distributions in the future.

The income from the portfolio, I have reflected before, notionally represents another additional full-time worker, effectively earning new capital each day on my behalf, at above the median wage. Over the past year this worker earned the equivalent of $68.79 per ordinary working hour.

Or to consider it another way, each hour of every single day and night last year the portfolio tirelessly worked to earn the equivalent of around $15.52 per hour, over 50 per cent more than the last financial year.

Six months ago, reviewing a record high in December distributions, I wondered where the tide would find its high water mark. The result this half year appears certain to mark it, for the next few years. The combination of capital payouts, surging equity markets, and a passing through of dividends deferred in the initial phases of the COVID-19 pandemic appears unlikely to repeat.

Quite simply, also, the portfolio could not long weather the equivalent of a six per cent distribution rate, and maintain its value in real terms. As things have been this way, they cannot remain so. The future remains undiscovered, and shrouded – as always – in the fog of uncertainties.

Explanatory Notes

Income distributions reported above do not include associated franking credits. My current preference is to seek to track cash actually delivered to my bank account as a tangible and easy to calculate measure. Last financial year franking credits valued at around $8031 were received from all shares, ETFs and Vanguard retail funds.

The income assumed for funds in the Plenti peer-to-peer lending platform is based on historical averages of the applicable lending rates used, together with the average balance over the periods.