Little islands are all large prisons; one cannot look at the sea without wishing for the wings of a swallow.

Sir Richard Francis Burton

This recorded journey towards financial independence started nine years ago, with an initial objective of building a passive income of $58,000 per annum by July 2021.

Since that time, goals have evolved and changed, with the most recent targets being achieved from January 2024 onwards, as well as temporarily before that.

Each year in early January I spend time reviewing my investment goals and how I plan to reach them.

This post talks about reflections arising from this annual review, updates my portfolio goal, and reviews the measures and assumptions I will use. It also discusses how I will approach management of the portfolio and associated finances given the current achievement of each of my past portfolio goals.

The aim each year is to have a clear written record of the objectives, approaches and reasoning underlying the plan, to serve as a reference point through the year to come. The process also enables the updating of plans and assumptions for changes in circumstances, thinking, as well as available data and evidence.

Little island? Reflecting on a post-journey agenda

The objective of this record at its commencement was to seek to test whether there were any hidden or invisible barriers to the actual achievement of financial independence, given a path of consistent investing over a long period.

Early posts around future goals were largely focused on setting specific financial targets, to put in place the foundations of financial independence, such as achieving a certain portfolio level, or amount of distributions.

At this point in the journey, following the formal meeting of past goals and targets, arguably the approach of setting yearly goals has less to recommend it. The task of a record is to focus on what is occurring, and may occur, rather than becoming trapped in formalities and rituals now existing beyond their natural utility.

Uncertainty and the potential for major market movements, and financial crises, do mean that all progress in quantity terms is provisional.

It would be within the expected run of financial markets for the portfolio’s equity component to fall 40-50 per cent in an exceptionally poor year. Similarly, more volatile components of the portfolio could suffer even larger falls, without falling anywhere outside of historical precedents. And of course, there is always the potential for entirely new precedents to be set, including ones that undermine the entire basis of the FIRE exploration.

This remains true, and yet there is another emerging, less urgent truth emerging over past years. This is that perhaps the main task is shifting from forging the portfolio, to a role of observing and monitoring its own internal processes, applying judicious action only where necessary.

A reason for this is the growing part played by internally generated compounding forces within the portfolio. Put simply, this means that the portfolio has grown to a level where it is less affected by small ongoing decisions or investment choices made. The goal perhaps switches to a more negatively framed one – of not acting in a way that interrupts, or disrupts this self-sustaining process of portfolio growth.

Again, humility is required, because compounding in equity markets does not occur by virtue of smooth annual 7 per cent glide-paths. It occurs in between brutal, sharp upward and downward saw-tooth moments in markets.

These movements themselves are demonstrations of the movement of the journey from one of deliberate, calibrated, controlled choices to a different stage. A stage requiring a greater sense of detachment from the impacts of market forces on the portfolio. And a stage that redirects energy from goal-setting in the financial sphere to other aspects of life.

The tasks that seem most relevant to this stage continue to be evolutions of the two set out for the last two years.

• First, to provide for a reasonably assured passive income which is consistent in real after-inflation terms with the target chosen.

• Second, to maintain reserves of cash that will be essential to future movement to entire reliance on investment returns and the application of the safe withdrawal rate to the portfolio over an extended multi-decade period.

Should financial markets fall substantially, it is possible I will use reserves in excess of the above requirements, as well as any regular distributions, to purchase new investment assets to restore in particular the targeted level of equity holdings.

Wings of a swallow: updating the target portfolio goal

The target portfolio goal was lifted to $3.0 million at this time last year, largely to account for shifts in annual ordinary earnings during a period of higher than average inflation. This followed a much more significant upwards movement to fully implement a ‘safe withdrawal’ rate approach in 2021.

To ensure maintenance of the real inflation-adjusted value of the target and resultant income, and consistent with the approach taken last year, I have updated my existing goal and formed an updated Portfolio Objective.

The new objective is to seek to maintain a portfolio of at least $3,250,000 through 2026. This should be capable of producing an annual income from total returns of about $112,000 (in May 2026 dollars).

Consistent with this overall target and a target 80 per cent allocation to equities, a secondary objective through 2026 will be maintaining a minimum equity target of $2,600,000.

The updated portfolio target is an increase of $250,000 on my previous portfolio objective, more than equivalent increase as last year. The key reasons for these objective and target changes are to account for movements in benchmark earnings, and bringing the target income into 2026 dollars in a period of above RBA target range inflation. Moving the previous target into nominal 2026 dollars and updating average ordinary earnings for real changes over the past year fully accounts for the increase of the target.

The passive income target for the objective is updated using May 2025 Australian Bureau of Statistics data (of average earnings of $2,083 per week). This is escalated for an growth in consumer prices of approximately 3.5 per cent across the period from May 2025 to mid 2026 (i.e. to $2,156, and $2,156 * 52 = approximately $112,000). This 3.5 per cent figure is a judgement based on the current range of CPI forecasts by the Reserve Bank.

The goal therefore seeks to reflect the approximate equivalent of average Australian full-time ordinary earnings in mid-2026. It remains above my current estimated average annual spending over the last three years of around $107,000.

This income goal is designed to reflect a ‘business as usual’ lifestyle, rather than a ‘leanFIRE’ approach.

The goal is a key and fundamentally personal choice.

In some circumstances, making this choice represents an irreversible ‘once in time’ decision about the approximate standard of living to be locked in and experienced across multiple decades – including those in which flexibility to adjust income or expenses may be circumscribed in completely unforeseen ways.

The target goal of adult ordinary full-time earnings represents an objective external measure of a continuing capacity to fully access and participate in the broad range of goods, services and daily experiences of those in the community.

That it continues to sits relatively close to my actual spending also provides an assurance that post-early retirement life would not see a material diminishment in, or undue limitation of, lifestyle.

In this way, the level is closer to the level of expenditure at which I think I am truly indifferent to working or not in terms of lifestyle.

Prison or freedom? Continuing use of a safe withdrawal rate approach

Five years ago I changed my approach to setting the portfolio goal by explicitly incorporating a safe withdrawal rate into its calculation. I will continue with this approach.

Prior to that I estimated the portfolio goal by dividing the passive income target by a projected average real portfolio return.

The real return assumption used in this past calculation was based on the total return arising from the portfolio allocation. These return assumptions are noted further below in the second half of this entry which reviews allocation plans and portfolio design.

Such an approach was a useful rough approximation of a safe withdrawal rate, and past annual reviews recognised it as an imperfect but serviceable proxy measure for use on the earlier stages of the journey of accumulation.

The weakness of this approach, however, was that it failed to properly account for sequence of returns risk. This is the potential for early negative returns affecting the portfolio in the first years of income drawdown to lead to unsustainably high portfolio withdrawals, depleting the portfolio irreversibly.

The change in approach in 2021 was made to move beyond approximations and to target explicitly a portfolio goal that better took into account a reasonable estimate of a sustainable safe withdrawal rate.

A target safe withdrawal rate of 3.45 per cent will continue to be used.

This figure underpins the updated portfolio goal (i.e. $112,000/0.0345 = $3,250,000, with some rounding).

Any safe withdrawal rate is at its core a highly individual decision.

In past years I have used a safe withdrawal rate of 3.5 per cent. In 2023 I reviewed this, and adjusted it slightly downwards to 3.45 per cent.

As with 2024 and 2025, this year I have not seen any new evidence that would warrant changing this revised estimate, and so propose to maintain it.

The steady horizon: safe withdrawal rate estimate maintained

The reasoning for the decision to maintain an estimate of 3.45 per cent remains the same as between 2023 and 2025, and is reproduced below.

The choice was informed by risk tolerances, personal factors, available academic and other studies and views about the value of historical data in forward-looking decisions of high and enduring personal consequence.

The primary basis for previous decisions on safe withdrawal rates has been the finding that based on historical Australian equity returns data over the period 1900-2011, a safe withdrawal rate of 4.0 per cent has had an 88 per cent success rate over a 40 year time horizon. This success rate lifted to 97 per cent at a withdrawal rate of 3.0 per cent.

A further study by Professor Wade Pfau, an eminent academic commentator in this area, has found that the maximum safe withdrawal rate for Australia using 1900-1979 equity market data was 3.68 per cent.

Factors considered in setting an initial safe withdrawal rate

These Australian-based findings might suggest a safe withdrawal rate around 3.7-4.0 per cent. Several factors, however, have led to a more conservative rate being adopted.

These factors are:

• Survivorship bias – Due to a historically strong equity market performance Australia has had one of the highest safe withdrawal rates in the world. Effectively projecting continued higher than globally average equity market returns indefinitely into the future is not likely to reflect a realistic central estimate of probable outcomes. Many other highly developed countries with comparable advantages have experienced lower safe withdrawal rates. There are no particular reasons to suppose that the outperformance of Australia’s equity markets over the past century will reliably persist (see Pfau An International Perspective on Safe Withdrawal Rates from Retirement Savings: The Demise of the 4 Percent Rule? 2010).

• Portfolio management fees not taken into account – Academic and other estimates of safe withdrawal rates routinely assume away real world investment management fees. For the investment portfolio at present, these average around 0.2 per cent per annum. Paying 1 per cent in fund expenses has been estimated to lower a safe withdrawal rate by 0.5 per cent (see Pye, G. 2001. “Adjusting Withdrawal Rates for Taxes and Expenses.” Journal of Financial Planning, Vol. 14, No. 4, p. 126).

• Statistical portfolio ‘success’ can look and feel a lot like failure – Many statistical ‘successes’ with a higher safe withdrawal rate would actually be close run exercises. This is because success is frequently defined in such studies as having at least $1 in the retirement portfolio at the end of the drawdown. Suffice to say, this does not match many people’s intuitive desire for a margin of safety and security late in life’s journey. In short, as this analysis shows, ‘terminal values’ and the experienced path of the drawdown matters.

Two additional factors, supported by some market evidence, might be argued to have implications for the safe withdrawal rate.

These are high equity market valuations and a low bond yield environment. Over the period from 2022 to 2025, persistently high equity market valuations and rises in bond yields towards more historical average levels means that these factors, now in tension, may be less persuasive considerations in informing the final rate, and have therefore not been given any weight in this review.

A 2021 study by Morningstar (h/t Aussie HIFIRE) examined some of the above listed factors, and projecting lower future returns estimated that a safe withdrawal rate for a 40 year period with an equity allocation of 80 per cent could be as low as 2.6 per cent (modelled based on a 90 per cent ‘success’ rate).

A similar Morningstar study in 2022 reviewed safe withdrawal rates in the context of higher bond yields and lower equity valuations across 2022. For a 40 year period (at a 90 per cent success rate), with the same equity allocation of 80 per cent, the safe withdrawal rate had risen to 3.1 per cent.

Reviewing international evidence of safe withdrawal rates

The most significant recent evidence on safe withdrawal rates for my considerations has been a paper from Anarkulova et at in September 2022 titled The Safe Withdrawal Rate: Evidence from a Broad Sample of Developed Markets.

This examines the question of safe withdrawal rates using a set of 38 developed country markets, and including hypothecated returns data from ‘difficult’ data periods typically excluded from such analysis.

The paper then analyses the resulting approximate 2,500 years of asset class return data from 1890 to 2015 to ‘test’ by simulations safe withdrawal rates across developed countries. The point of this analysis is to account for the kind of survivorship bias inherent in using only Australian or US data sets to determine safe withdrawal rates.

The results therefore represent a more realistic, ex ante or forward-looking, analysis of possible safe withdrawal rates, taking into account the fact that US or Australian returns in the future are quite likely to resemble broader averages from developed markets.

This removes the often implicit, and potentially dangerous, assumption from solely US or Australian-based withdrawal rate analysis that these markets will unquestionably continue to produce above average returns in the decades ahead. The new paper adds significantly to similar evidence in the previously mentioned Pfau analysis from 2010.

The headline finding of Anarkulova et al (2022) is that the 4 per cent ‘rule of thumb’ commonly applied and cited in retirement planning and many financial independence sources is not ‘safe’.

In fact, pursuing the standard ‘4 per cent rule’ applying this more comprehensive global data set results in a failure rate of around 17 per cent, or running out of portfolio income in nearly one in five cases. The work focuses its central case on a safe withdrawal rate of 2.3 per cent, for a traditional retirement horizon, with a 5 per cent chance of failure and with a standard 60/40 equity and debt portfolio, but also provides further iterations and scenarios.

Using some extrapolation from the 2022 Morningstar analysis, and some of these tailored scenarios that apply more closely to my circumstances and portfolio allocation, the data in Anarkulova would suggest a starting point for a safe withdrawal rate of around 3.3 per cent.

Estimating a final estimated safe withdrawal rate: accounting for additional factors

These factors and evidence discussed above all argue for an initial safe withdrawal figure lower than 4 per cent.

The 3.3 per cent rate suggested by the Anarkulova analysis represents a key initial starting point for a final estimate.

Yet there are other factors to consider in reaching a final point estimate.

First, as noted safe withdrawal analysis can often exclude the impact of portfolio management costs. To account for this in the final estimate I lower the Anarkulova estimate by 0.20 per cent, or 20 basis points, which is the approximate average expected portfolio costs over the long term.

The second factor to account for is the potential value of flexibility in withdrawal rates and approaches.

The flexibility to not draw on one year of distributions can make a significant difference in the performance and success rate of a reasonable safe withdrawal rate. Similarly, this (pdf) Canadian Vanguard study shows that a dynamic flexibility in spending can lift a safe withdrawal rate for a high equity allocation portfolio across 40 years from 3.5 per cent to 4.3 per cent.

The 2022 Morningstar research paper discusses the potential impacts of a range of flexibility strategies in actual withdrawals. These include rules such as reducing spending by 10 per cent temporarily after a negative annual portfolio return, or forgoing annual inflation adjustments in similar circumstances.

The findings are that these strategies can increase safe withdrawal rates (noting a limitation that this analysis is using only US returns data) by 0.2 per cent and 0.5 per cent respectively. Other more complex ‘guardrails’ strategies are presented as potentially offering up to a 1.8 per cent uplift to safe withdrawal rates.

Reaching a final point estimate for the safe withdrawal rate

Taking the initial 3.3 per cent rate from the Anarkulova analysis, my current preferred approach is to then deduct 0.2 per cent to account for portfolio management fees, resulting in an adjusted rate of 3.1 per cent.

I have yet to finalise my precise preferred drawdown approach and strategy in action, but it will like have elements of flexibility, as well as using a 12-month cash ‘bucket’ to avoid some unnecessary withdrawals of capital in any shorter duration adverse market events.

Taking the range of potential uplifts from the ‘10% reduction’ and ‘forgoing inflation’ strategies in the 2022 Morningstar report results in a range of 3.3 to 3.6 per cent. I then select the mid-point of this range, reflecting uncertainty over which of these specific strategies I may seek to adopt.

On balance, taking all these considerations into account, a target value of 3.45 per cent appears to be appropriate as a reasonable estimate, and to match the personal degree of assurance I am comfortable with in my personal circumstances.

This is very slightly lower than the previous 3.5 per cent figure adopted, but is supported by more detailed evidence, and a more explicit accounting for each factor considered.

The presence of a superannuation portfolio continues to provide an additional approximate 37 per cent ‘buffer’ in dollar terms over the new target, potentially reducing the risk of poor ‘tail end’ outcomes that would arise from strict reliance only on the financial independence portfolio.

An indication of the impact of superannuation on the ‘margin of safety’ actually in place is that using January 2026 figures, the target income of $112,000 would represent a 2.3 per cent drawdown of the sum of all financial assets (portfolio assets excluding Bitcoin) and current superannuation holdings.

One factor not accounted for which this additional margin may assist with offsetting is the fact that most safe withdrawal rate estimates and resulting income estimates to do not explicitly account for tax liabilities incurred.

The changing role of the goal and pre-conditions of financial independence

Two years ago I set out both the possibility of the target being achieved, and being blown off course, and the journey’s end remaining elusive.

In mid-2025 I stepped into a permanent part-time position rather than full retirement. This means an income still flowing in, and some, albeit reduced, capacity to make new investments should I choose.

In turn, this means that the transition to full reliance on portfolio income may not occur through 2026, or perhaps early 2027.

This transition means there is a degree of flexibility, optionality, which makes hard and fast rules or preconditions a little less relevant than journey’s completely ended in a full stop.

Despite this, the conditions set out two years ago appear perfectly sensible and serviceable ‘checks’ through this phase.

These conditions are:

1. Portfolio target being met – in particular, is the portfolio target met or exceeded, such that applying a 3.45 per cent safe withdrawal rate can be expected to be sustainable over a forty year period? The logic for this target and withdrawal rate is detailed above. While already met, a large financial market event could certainly result in this condition being not fulfilled.
2. Achieving the minimum equity target – has the minimum equity holding targeted been achieved (i.e. whether the equity component of the portfolio is at its target level) to ensure that the long-term core of the portfolio which is assumed to generate income and capital growth is able to serve its function? If the equity holdings are below this level, action would be required to address this.
3. Cash reserve in place – is a capital reserve in place that is equivalent to at least one year of normal expenditure (i.e. $107,000), to minimise or avoid required portfolio withdrawals in future equity market drawdowns?

At the end of 2025, all three of these three conditions were met, just as they were at the end of 2024.

As noted above, the minimum equity target, has required updating to reflect the increase in the overall portfolio objective already detailed. This revised equity target is estimated by multiplying the overall portfolio target with the target equity allocation (of 80 per cent, or 0.8).

This year my approach will continue to be to focus on maintaining each of the three conditions.

Measures on the journey to financial independence

In early 2024 I made some revisions to the benchmarks used to track the achievement of financial independence.

While the measures are fully met now, and in one sense therefore redundant, they still provide a valuable service in a couple of key respects.

First, they indicate, especially in conditions of future market falls, the ‘margin of safety’ until the theoretical goal is no longer met.

Second, the provide a partial link through the year to the dynamic impact of expenditure choices made through the year, and their impact on this same ‘margin of safety’. This occurs through the measure which tracks the degree to which the financial portfolio – comprising only traditional assets – might be expected to meet the total average level of expenses incurred over the last three years.

The metric of Financial portfolio income as % of total average expenses will, therefore, continue to be reported.

This measure is defined as percentage progress toward a strictly financial portfolio value capable of sustaining a moving average of nominal estimated expenditure (using the 3.45% safe withdrawal rate).

Data supporting this figure has been recent updated, with a review of the most recent fixed set of expenses that are added to credit card expenditures to form the total. This analysis shows total average expenses of around $107,000 using the past three years of actual monthly expenditure.

I will also continue to report the second metric added more recently, being Target equity holding. This measure, which I have reported consistently since 2022, will be equal to the current equity holdings in the portfolio, divided by the final targeted equity allocation.

I will continue to report these progress percentages in future monthly updates. An illustrative example of this reporting, using the portfolio position on 1 January of this year as inputs, is set out below.

FI measures – Example

Measure	Progress
Portfolio objective – $3,250,000	156%
Financial portfolio income as % of total average expenses (3 yr average) – $106,500	117%
Target equity holding in portfolio – $2,600,000	114%
Financial portfolio income as % of target income – $112,000 pa	111%

Wishes beyond the sea

This is now the tenth time a portfolio goal has been either set or reviewed.

Typically, this would involve updating the desired target income, for inflation or average wage movements, testing safe withdrawal rate assumptions with recent developments, and identifying the resulting portfolio goal.

A significant reset occurred in 2018, where the target income moved from $58,000 to $80,000, reflecting a movement to more closely track the desired outcome of replicating the income of adult ordinary earnings, through the portfolio income. This entailed an increase in the portfolio target from around $1.5 million to $2.0 million, around a 38 per cent increase.

Since that time, annual updates of the target have tended to be smaller, averaging around 3.8 per cent per year.

The exception is this year, which has seen a 8.2 per cent increase in the required target, a result, perhaps, of movement in the ordinary average earnings measure, and the resumption of real increases, as well as higher than average inflation.

Had the original target been maintained and only updated for inflation, the portfolio target would have been around $2.0 million this year, and would have produced a sustainable withdrawal income of around $68,000, around 60 per cent of average ordinary full time earnings. Updating the goal in real terms by around $1.0m, therefore, has involved the choice of a far different form of lifestyle and freedom in expenditure than original somewhat naively set targets entailed.

As noted last year, it is a salutary ‘forcing function’ this process is that it demonstrates the challenge of achieving a sustained level of financial independence, given the twin effects of inflation and any advancing average earning benchmark.

To lift beyond these powerful forces, wings of a swallow, and a careful eye to the weather ahead are requirements.

Reviewing the investment plan and assumptions

Change is annoying. But certainty is absurd.

Voltaire

Each year I review my investment policy to ensure it stays relevant to available data and evidence, and will serve my ultimate investment goal of financial independence.

The summary is based on my past reviews and decisions, and is largely unchanged from 2024 and 2025. It is designed to serve as a reference for the chain of reasoning underpinning portfolio design and allocation decisions through the year – so it remains unchanged where my conclusions have not changed.

In 2019 I increased the equity allocation in the portfolio to 75 per cent. In 2021 the policy was adjusted to move towards a long-term target of an equal allocation of global and Australian equities over the next several years.

The most significant change following the 2022 review was to slightly increase the overall equity allocation, to 80 per cent, by reducing the target bond allocation.

The goal of reaching an equal allocation of global and Australian equities has changed in this review. The current approach target allocation adopted in 2023 is discussed and revised further below.

Specific asset allocation targets

Based on the review and considerations below the portfolio allocation targets are as follows:

• 80 per cent equity-based investments, comprising:
  • 52 per cent international shares (e.g 65 per cent of equity investments)
  • 28 per cent Australian shares (e.g 35 per cent of equity investments)
• 5 per cent bonds and fixed interest holdings, comprising:
  • 2 per cent Australian bonds and fixed interest
  • 3 per cent international bonds and fixed interest
• 7.5 per cent physical gold holdings and securities; and
• 7.5 per cent Bitcoin.

Reasons for allocation targets and assumed asset returns

Assumed equity returns

The equity component of the portfolio provides the fundamental engine of returns in the portfolio, with the most sustained historical record of outperforming other traditonal asset classes, and maximising after inflation returns.

Calculation of the overall portfolio target previously involved setting an assumed return for each asset class, however, this has been replaced since 2021 with the use of the safe withdrawal rate.

To anchor forward expectations, however, I still find the estimation of assumed returns a question of interest.

In terms of long-term real equity returns, this year I have adopted an estimate 5.1 per cent based on the geometric mean of Australian equity returns over risk-free assets over the period 1883 to 2024.

For my specific purposes, the geometric mean appears to continue to be more appropriate than the previously used average of the arithmetic and geometric mean, and its lower value also reflects lower expectations going forward.

For global equities, the equivalent real return estimate used last year was 5.2 per cent, a long-term historical figure (from 1900-2024) sourced from the 2025 Global Investment Returns Study.

Allocation between Australian and global equities

The split between Australian and international equities is designed to maximise total returns and minimise undue portfolio volatility, while taking advantage of the tax-advantaged nature of Australian franked dividends.

Approach to allocation – movement to 50/50 allocation

The specific equities sub-targets changed in the investment policy review of 2021.

Previously, I had sought to achieve a target 60/40 split between Australian and foreign equities, which an academic survey published in 2013 estimated to be optimal for most Australian investors (see Klement, Greenrod and O’Neill Optimal Domestic Equity Allocations for Australian Investors and the Role of Franking Credits published in the Journal of Wealth Management and also discussed previously here).

A key finding of that study is that Australian equity exposures at higher rates significantly increase portfolio volatility, and maximum potential losses.

The specific optimal 60/40 split suggested by the study is, importantly, a product of the historical data and the characteristics of volatility in past markets.

As such, it retains value in application only to the extent that fundamental relationships between Australian and global equities may not have changed in the period since 2013. I have previously noted that as time passes, that assumption becomes more questionable, meaning that a 60/40 split provides no certainty of continuing to be optimal going forward.

In 2021 I changed the target allocation to a 50/50 split of Australian and foreign equities. This approach was adopted to:

• Assume a ‘neutral’ position on relative equity market performance – Over the long-term in conceptual terms, an equal allocation reduces the portfolio risks of any future Australian equities underperformance compared to global equity indices.

• Recognise the after-tax benefits of franking credits – The remaining 50 per cent weighting to Australian equities still sits close to the optimal balance for reduced portfolio variance and maximisation of franking credit benefits suggested in the Klement et al paper discussed above.

• Reduce portfolio variance – A 50/50 per cent weighting is supported as a “minimum variance” (i.e. lowest volatility) portfolio allocation by this 2012 Vanguard study (pdf).

• Recognise that pure ‘market capitalisation’ weighting is not required – Due to correlations between Australian and global markets, and the specific benefits provided by the current franking credit regime, it is not optimal to hold the Australian market at the low weighting (2-3 per cent) which would arise from a pure market capitalisation weighting approach.

The Vanguard study (pdf) mentioned above provides an excellent structured framework for individual investors thinking about these issues (see in particular Figures 4 and 11).

A revised approach: movement to greater international diversification

Through 2025 I reviewed State Street Global Advisers Equity ‘White Paper’ Home Bias in Australian Equity Allocations: Diminished Portfolio Outcomes (October 2024). This report provides updated estimates of efficient optimised allocations using a 15-year data set covering 2009 to 2024.

The report generates much higher estimates of the ‘maximally efficient’ level of international allocation based on this period, and much lower estimates of the impact of franking credits in raising optimal domestic equity allocations.

As an example, and using some important assumptions, the paper suggests many Australians would achieve the ‘Maximum Sharpe’ (i.e. the most return per unit of risk or volatility) allocation with an international allocation of 91 per cent, and a domestic allocation of 9 per cent. Other interesting but less formal analytical work has posited a ‘Sharpe point’ of up to a 33 per cent Australian allocation, and derived longer-term average estimates over 1970 to 2024 of between 32 and 41 per cent.

Interestingly, for the period, the SSGA work estimates the conceptually distinct point of ‘minimum volatility’ – which was the basis of my previous allocation decisions – at a 53/47 domestic and international allocation.

This brings into focus the question of departing from a ‘volatility minimising’ standard, towards a ‘maximum Sharpe’ point in future equity allocations.

There are a range of considerations in play.

As I have noted, in this phase of the journey, potentially volatility minimisation is a desirable objective, particularly as bonds have failed at this task in recent years. Yet, adopting this involves a trade-off from the theoretically optimal return per unit of risk, and this performance penalty obviously has the capacity to compound over future decades.

In making this decision, the features and limitations of each study also need to be taken into account.

Some studies rely on long data series, potentially more representative of multiple cycles than shorter periods, but, equally, potentially less relevant due to the changing underlying composition and characteristics of Australian equities and their foreign counterparts.

Importantly, the SSGA study also bases its estimates on indexes that assume the holding vehicle is a superannuation account, and the small difference in the overall impact of franking credits to the final optimal allocation is stark, compared to the 2013 Klements paper.

An underpinning, simplifying basis for the current equal allocation has been that in a forward-looking sense, it avoids assuming either international or domestic equities will outperform. It assumes, in short, a ‘coin-toss’ on the question of whether returns will be maximised by greater global or domestic investment exposure.

Yet such an approach quite clearly does still represent a significant risk and exposure to the fate of domestic equities, albeit mitigated by the fact that Australian and international equities have less than full correlation, and Australian markets may benefit in some circumstances that result in falling global market valuations. As a crude illustration of this, financial and materials equities (such as BHP, NAB and the Commonwealth) listed in the Australian market make up around 25 per cent of the value of the total equity portfolio.

History has some other information to guide the process for decisions.

For example, it tells us that Australia’s realised equity market returns across the past century have been among the highest in the world, alongside the United States (which, relevantly, constitutes around 70 per cent of MSCI global equity benchmarks). This introduces the conceptual future risk of ‘diversifying’ from one historically ‘lucky’ market, into another arguably ‘lucky’ market – to the extent that this historical record reflects either survivorship bias or an outcome of pure chance.

The new information in the SSGA paper is – in my personal view – sufficiently compelling to warrant a change in my personal approach and allocation targeting.

As the portfolio has grown, I have been increasingly aware of the large allocation to Australia equities, and the potential vulnerability of this holding in a range of clearly plausible future scenarios for a single trade-exposed commodity exporting nation.

These scenarios include geo-political conflict, increased trade restrictions, or global recession.

Plausibly, further international diversification at the margins reduces overall portfolio exposure to these risks – even in circumstances where the same risks will impact other markets. It cannot also be discounted, as well, that Australia might once again be fortunate, and impacted less, or even benefit from some of these same types of positive events and trends, as it has generally since the early 1980s.

At present, my tentative ‘on balance’ judgement is that further international diversification may be a risk-reducing, and long-term return enhancing step, compared to the current 50/50 allocation approach. This is an inevitably imprecise and personal ex ante judgement, which may well prove incorrect after the fact.

Implementing the revised approach

There are two immediate issues with any implementation of this judgement.

First, the degree of movement.

The SSGA report findings suggest something approaching a 90/10 allocation between international and Australian shares, but based on a relatively short observation period of 15 years.

This position may well be substantially influenced by its assumptions around the marginal tax liability of a superannuation vehicle, as compared to a ordinary Australian investor. The original Klements study indicates an Australian allocation of 30-40 per cent may be optimum, in terms of minimisation of volatility and maximum possible loss, from a longer, but older data sample.

With these imperfect guideposts, a reasonable approach for my portfolio approach and circumstances may be to allow for an increase in international equities up to, initially, a range of 60 to 70 per cent of total equity holdings – with a guiding target of 65 per cent), thereby moving closer to the maximum Sharpe point indicated in the SSGA study, while also being consistent with minimising maximum potential losses and volatility as indicated in the Klements paper.

The second question, is the timing or method of movement.

On this issue, my plan is to avoid a rapid or mechanistic pursuit of a higher international exposure, in favour of a more gradual and organic movement through time, minimising avoidable tax liabilities or transaction costs.

Under this approach, rebalancing will be achieved by means of new investments, or the direction of reinvestments made over time into international equities, and occur over a period of 5-10 years.

Bonds and fixed interest

Bonds and fixed interest are intended to play a role in diversification, reducing overall portfolio volatility.

The assumed return of 1.7 per cent for these assets is in line with long term global averages measured since 1900, sourced from the 2025 Global Investment Returns Study and based on data from the Dimson, Marsh and Staunton book Triumph of the Optimists – 101 Years of Global Investment Returns.

A separate review of bond holdings in the portfolio and the relevant investment literature has reinforced the value of a small bond holding, but caused a slight adjustment in the target allocation from a simple equal weighting of Australian and foreign bonds, to a position that reflects the greater diversification benefits of international bonds.

In early 2022 the target bond allocation was reduced from 15 per cent to 5 per cent.

This was due to my personal assessment that the expected real return and diversification benefits of bonds going forward would be significantly reduced in market conditions likely to persist over the next 5 to 10 years.

At that time it was difficult to see bonds producing returns close to their long-term historical results in the near-term, following a multi-decade fall in interest rates that has acted as a sustained tail-wind for returns. In 2022 I observed that with rates at near decade lows, the prospect of significant capital loss was much more likely than any continuation of capital gains that investors have enjoyed since the early 1980s.

The substantial rise in bond yields through 2022 supported this view, and delivered deeply negative real returns for bonds. Despite the recent yield rises, at the point of investment, many bonds would currently still be expected to produce only narrowly positive real returns.

The recent falls in bond prices and rises in yields are suggestive of potentially better returns ahead, however, this remains critically contingent on inflationary outcomes over the short and medium-term.

My assessment remains that current and potential future government policies and monetary policy authority decisions are likely to dampen or eliminate the potential for bonds to profitably serve their traditional role in portfolio design.

This is a set of circumstances – with such policies sometimes termed ‘financial repression’ – that has been experienced at other times of relatively high public sector debts at a global level.

Gold

Gold is as described previously in the role of gold and Bitcoin in the portfolio primarily included in the portfolio as a non-correlated financial instrument for diversification, and to act as an insurance against extreme capital market events or conditions. I have invested in gold, principally through an exchange traded fund, since mid-2009.

No real return is assumed for gold assets held.

Bitcoin

For a significant period it has been uncertain exactly what role Bitcoin may or may not play in investment markets, or as an emerging store of value. As such it remains a high risk and volatile component of the portfolio. No real return is assumed for Bitcoin held, despite its strong performance across the past decade.

Bitcoin is included as an asset in the portfolio following the unexpected growth in value of a small exploratory investment (representing around 0.5 per cent of 2015 portfolio value) to a sizeable component of current overall portfolio value.

At different times Bitcoin has exhibited different correlations to equities, but its overall and enduring investment characteristics going forward cannot yet be clearly disentangled from price impacts from its wider adoption to date.

Generally, over the medium-term it has had an extremely low correlation to the price of gold, potentially making it a valuable additional source of diversification at times where gold fails to serve its intended objectives within the portfolio. Bitcoin also represents, in some senses, an ‘option’ on some forms of monetary policy breakdown and market disorder.

In this way, I view it as broadly part of the ‘alternatives to equity’ portfolio (including gold and bonds) which has constituted between 20-25 per cent of the target portfolio over recent years.

The purpose of this component of the portfolio is diversification and protecting real wealth and purchasing power in circumstances where the primary ‘engine’ of the portfolio – equities – may temporarily be adversely impacted by market events.

Recognising this, and in line with its sharp volatility, and the potential risks and costs of seeking to actively trade Bitcoin, I have not and do not propose to trade to target the specific Bitcoin target allocation.

Rather, the allocation level of 7.5 per cent represents an aspirational average level that I would be comfortable with holding over an extremely long-time frame.

The achievement of this target allocation in any particular year or even five year period is a matter of less importance to me in my personal circumstances. Of more significance is seeking to target over time around 20 per cent of the portfolio being non-correlated to the performance of equities.

Property

I have no formal property allocation for investment purposes, following my exit from my tiny exploratory investments in fractional residential real estate through BrickX.

In the current market environment my assessment is Australian property is likely to enjoy low yields and returns for a considerable forward period, and not offer sufficient diversification benefits over Australian and global equities or other available asset classes. Where tax effective avenues exist to exit this allocation, they will be taken.

_{* This specific portfolio allocation and approach has been determined based on my personal circumstances, objectives, assessments and risk tolerances. It is not a recommendation to invest in any particular investment product, security or asset, and investors considering these issues should undertake their own detailed research or seek professional advice.}

Note for readers
Over the last year, there has been a noticeable degradation in the useability of my standard blogging interface. As an alternative, and because I am not interested in becoming a coder, plug-in or website management expert, I have created a rough and ready backup Substack and imported past posts. The formatting of past posts may not be as tidy as here, but should the blog ever seem to ‘disappear’ or cease, it will likely just be a signal that I have switched entirely to Substack and started posting there.

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Disclaimer

The specific portfolio allocation and approach described has been determined solely based on my personal circumstances, objectives, assessments and risk tolerances. It is not personal financial advice, or recommendation to invest in any particular investment product, security or asset, and investors considering these issues should undertake their own detailed research or seek professional advice.