Its important that in your pursuit of Financial Independence that you set yourself goals, decide on an investment strategy and then keep yourself accountable to both. Smart investors educate themselves, and set to investing regularly
My goal is to reach financial Independence (FI), start a family and then eventually have enough passive income coming in where I can afford buy my own block of land in the country to raise my kids. This means to sustain me forever according to the 4% rule, I need to buy and hold a portfolio of around $600K initially, increasing to around $1M for FI with a family.
One of the unique tax retirement structures in Australia is superannuation or simply called super. I have a great retirement package with my company that pays just over a quarter of my wage into my superannuation accounts each year, and I also have to pay the minimum personal mandatory post tax 5% of my wage contribution. I also salary sacrificed up to the maximum concessional cap (under this arrangement you only pay tax at 15% vice the marginal rate of up to 47%).
So whilst I am being mindful with my spending, saving and investing for a baseline Financial Independence, I know that the Get FI Portfolio doesn’t need to last me forever – only around 25-30 years until I can access my super nest egg which would then do the heavy lifting. This means although I am basing my FI number on the 4% rule, I could actually draw it down at a much higher rate, even over double the 4% rule and it would still safely last me – I have chosen a 7% ‘fast draw’ down as a starting point. Market crashes could affect this, but I also have some diversified streams of passive income from my other businesses. If a serious market correction occurred and cutting back on expenses wasn’t enough, I could pick up some part time work to see the bear market out. I am also actively working on developing new income streams.
Working backwards, this means I would only need about $300K of ETFs for FI, or about $500K for FI with family (or FatFIRE). Although, 30 years is a long time and I am sure there might be some legislative changes and potentially even a lifting of the preservation age by the time I get there. Based on those unknowns, and the fact that I truly love and am passionate about my job, I am happy to continue flying for a little longer to increase the cushion.
I am still flexible, but currently weighing up whether working full time as a Pilot would be appropriate with a young family, or whether I should convert to a flexible or part time work arrangement. Of course another option is whether I should simply hand back my wings and focus more on my family, recreation and my businesses. Thankfully I still have a few years before I need to cross that bridge, so for now I will continue being as ruthlessly frugal and efficient as possible using my Investment strategy!
Personally, I follow a rock solid and idiot proof investment strategy, which combines the four strategies of Lump Sum investing, Dollar Cost Averaging, Buy the Dip, and buy and hold. I call this the Financial Independence Investment Strategy (FIIS!)
I aim to keep myself accountable in a few ways, one of which being this website! I have some very close family, mates, business associates and networks and we all try our best to keep ourselves accountable to each other, discussing our earnings, budgets, savings and investments. The FIRE community itself has actually proved to be an awesome way to stay accountable to your goals with your peers.
One of the biggest things that investors face is the decision to adopt an investment strategy. There are a few out there, and sometimes they have conflicting actions – one of the biggest choices investors come up against is how to deploy their cash savings into investments
Dollar Cost Average / Dollar Cost Averaging investing
You definitely would have come across the term dollar cost averaging. sometimes this is referred to by finance boffins as systematic implementation. This is where you slowly drip feed your cash stack into the market over time, gradually buying assets to average out the price you pay. It is an act to try and overcome volatility (or random price fluctuations) in the market.
Systematic implementation provides some protection against regret. Systematic investment of a large sum can be thought of as a risk-reduction strategy. Such an approach can moderate the impact of an immediate market dip. Historically, however, the trade-off has been a lower return in the majority of market scenarios.Daniel B. Berkowitz Andrew S. Clarke, CFA Christos Tasopoulos Maria A. Bruno, CFP® , Vanguard Research https://personal.vanguard.com/pdf/ISGDCA.pdf
Dollar Cost Averaging, or systematic investment is not actually an investment strategy! The investment strategy is actually what you are buying, but slowly drip feeding your cash into those assets is technically a risk avoidance measure – people are fearful that the market will crash right after they make an investment.
If you are truly buying for the long term, this shouldn’t bother you; as you should know that the market continues over time to rise, and whats really important are the dividends along the way. Cut the emotional crap and focus on what really matters (or as Mr Money Mustache might say, toughen up and grow a Money Mustache!)
Lump Sum Investing
The guts of lump sum investing is that the market goes up more times than it goes down, and it goes down much less than it goes up (over time). Many investors are fearful of lump sum investing, but Financial theory and mathematical evidence shows that most of the time, the best way to invest your money is all at once. It might sound a bit confusing, and don’t take my word for it- check out the statistical analysis conducted by the Vanguard group here!
On average, an immediate lump-sum investment has outperformed systematic implementation strategies across global markets. This conclusion is consistent with finance theory, as immediate investment exposes cash to (historically) upward-trending markets for a greater period of time.Daniel B. Berkowitz Andrew S. Clarke, CFA Christos Tasopoulos Maria A. Bruno, CFP® , Vanguard Research https://personal.vanguard.com/pdf/ISGDCA.pdf
Its not just Vanguard that agree, check out this review of Maciej Kowara and Paul Kaplans paper “Dollar-Cost Averaging: Truth and Fiction” by Tom Lauricella of the the MorningStar financial group.
Kowara and Kaplan show in “Dollar-Cost Averaging: Truth and Fiction” that historically, Lump Sum Investing has produced higher returns than Dollar cost Averaging. Ironically, they also show that Lump Sum Investing also produced more certain results than Dollar Cost averaging, meaning that Lump Sum Investing can actually LOWER your investment risk.
Buy the Dip – Value investing
You can’t predict the market. Volatility is a fact of life and prices will bounce around sometimes seemingly randomly. The market is over time rational, but in the short term people are irrational and make investment decisions quite foolishly based on emotion such as fear and greed.
Buying the dip simply means you take a value based approach to investing; you buy what is good value. Often this means as Warren Buffet says, buying a stock that is ‘On the nose’ with investors – The underlying companies and holdings are good, but its not the flavour of the month for some reason.
Value investing for me, means buying a stock below its Net Asset Value (NAV) or Net Tradable Assets (NTA). There are a host of free tools online to work out if a closed end fund like a Listed Investment Company is trading at a discount or premium to its NTA or NAV. One of the best ones I like belongs to Pat the Shuffler and can be found here. You should note that most ETF are open ended funds, so they will always trade exactly AT their NTA/NAV (sorry guys, no free lunches there – if the LICs aren’t at a discount, just stick to the ETF at least your getting the market rate).
If you want to delve deeper into the world of Value investing, have a read on Forbes or check out this paper written by Jesse Livermore, Chris Meredith and Patrick O’Shaughnessy from O’Shaughnessy asset management.
Buy and Hold – Long term investing
Trading stocks short term is a mugs game.. All you really do is make your brokerage agent richer, complicate your tax return and statistically, you get taken advantage of by big time investment firms waiting to pounce on your mistakes. If you want to know more about that last one, check out the book ‘Flash Boys’ by Michael Lewis
Its not about Timing the Market, but about Time IN the marketWarren Buffet, CEO Berkshire Hathaway (the Oracle of Omaha)
The majority of millionaires made in the stock market are those who Buy and Hold (and reinvest their dividends). I find one of the best ways to remove company risk is to simply buy the index through a good quality, diversified and ultra low fee ETF or Exchange Traded Fund
Financial Independence Investment Strategy FIIS
FIIS is a super simple strategy which combines all of the above. My investment strategy (which works for me) is based on mathematical evidence, human psychology and quite simply, works for me because I am lazy.
All I do is make a regular investment decision every fortnight on which index funds to purchase and hold (ideally forever). That’s it – Easy as! And it takes about 5 minutes every fortnight.
If I receive a windfall, I simply add this to my regular investment allocation and invest it straight away, as a lump sum, into whatever is good value at the time. This could be from a large dividend, special dividend, tax refund, profit from a project, extra allowances from work, a gift – anything! Statistically, the sooner you invest the money, the better.
Rather than buying a set amount of shares every fortnight, I allocate a set amount of money. This is a way of helping to automate and budget my investment strategy (which also has a few other awesome benefits).
At the moment, my goal is to purchase $3K worth of index funds every fortnight; the majority of this comes from my job working as a pilot, but I fill the gap using income from my passive investments (reinvesting dividends from the portfolio) as well as that from some side hustles (such as eBay selling, website and property developments, and T-shirt/sticker sales).
In terms of which assets and index fund I buy, I split my purchases across 9 different index funds. This helps me take advantage of ‘Buy the Dip’ Value investing as I can simply buy whatever is good value at the time. These include Australian, US and international shares, with a focus on Australian shares due to their high dividend yield and franking credits.
Specifically, these 9 are spready across 5 ultra low fee diversified stock market index ETFs, and 4 low cost diversified LICs which focus on increasing dividend streams to shareholders. I purchase these all through the Australian Stock Exchange, but if you live in another country you can easily purchase these same or similar products through your exchange.
The Vanguard ETF products are all available on global markets as they can be internationally domiciled (different name for the wrapper, same parcel of shares) as well as there may be similar low fee LICs on your exchange.
- Betashares Australian top 200 index fund (ASX:A200) MER = .07%
- Vanguard Australian shares top 300 (ASX:VAS) MER = .10%
- Vanguard Total US Market (ASX:VTS) MER =.03%
- Blackrock iShares S&P 500 ETF Total US market (ASX:IVV) MER = .04%
- Vanguard Total world ex US (VAS:VEU) MER = .09%
- Australian Foundation Investment Company (ASX:AFI) MER = .14%
- Milton investment corporation (ASX:MLT) MER = .12%
- Argo Investments (ASX:ARG) MER = .16%
- Brickworks investments (ASX:BKI) MER = .10%
You might be wondering why the hell I would buy say BKI with its MER of .17% over the VTS with its truly amazing .04%. This is a valid question, and the reason I include some of these LICs is that due to their closed end nature, they have the ability to trade at a net premium or discount to their total net asset value (NAV) sometimes called the net trade able assets (NTA).
These figures are published every month (you only care about the pre-tax NAV or NTA figure) and you can interpolate inter month using the relative performance of the index with some simple maths, or alternatively using Pat the Shufflers LIC discount spreadsheet – seriously awesome work Pat!
This means that although your paying a higher MER, you might be able to snag a discount and buy the LIC at 1 or 2% under its fair value. Lets be realistic here, on $100K invested we are talking about the difference between a yearly fee of $40 in VTS with $170 in BKI – if you managed to buy it at 2% undervalued, you’ve nabbed yourself $2000 in value which is over 15 years worth of paying the higher management fee. And if we are talking about VTS vs MLT, its 25 years worth.
The amount invested and numbers here are arbitrary, but the percentages work for any value trade. Whilst I have used VTS as an example to be conservative, US shares generally speaking are more geared to capital growth vs dividend yield, so a fairer comparison to the Aussie LICs are the Aussie index funds. A 2% purchase discount on MLT compared to A200 equates to 40 years of free management premiums!
So which ETF or LIC should I invest in?
The debate between ETFs and LICs and which is better rages on in the Financial Independence (FIRE) community, but honestly if you choose either you are going to fall pretty close to dead on the mark. Actually getting started, and investing earlier is going to have a much greater influence than the difference between these two factors.
In a nutshell (and probably grossly oversimplifying) ETFs are a relatively straightforward open ended trust structure which must payout all dividends directly to share holders within a financial year (or face hefty penalties), wheras LICs are a closed end corporate structure which can retain earnings for future distribution.
This means that if the stock market is raging and throwing off big cash dividends, your ETF must distribute this higher dividend to you and you might get pinged with some higher income tax, and then in the bear years the ETF might have a reduced dividend payout. The LIC on the other hand can retain earnings and feed it back out to you over time in a much smoother and predicable (and therefore tax efficient) manner, which a lot of retirees prefer.
ETFs automatically rebalance depending on the index, which due to market capital in Australia is fairly heavy on financials and mining stocks, and can result in capital gains tax events. LICs on the other hand employ a fund manager to pick stocks. Whilst I am fundamentally against stock picking (especially when you have to pay a premium to do so like most actively managed funds) the older low cost conservative LICs have a proven track record. Their portfolios mostly mimic the index with the ability to deviate away from some of the larger speculative sectors such as mining and focus more in high dividend yielding sectors such as manufacturing.
But its not just the fact that you can buy a LIC for a price below its value that I like. The LICs I own have a strong history of producing increasing dividend streams to shareholders. And ultimately, we are building a FI portfolio to replace the income we earn as an employee, so we want a dividend stream right?
I’ll delve into this deeper in another article, but the Thornhill or dividend investing approach is incredibly tax efficient in Australia due to franking credit refunds and the unique tax nature of retirement. Boglehead investors wanting to sell down parcels of shares can also take advantage of a 50% CGT exemption for holding them over a 12 month period, but they are still exposed to the risk of timing the market when they do so. So the LICs provide a great product with reliable, increasing and highly tax effective dividend stream, which aren’t really affected by market fluctuations, as well as the ability to purchase it at a discount.
Seriously, just tell me which ETF or LIC to invest in!
OK so with a bit of background between ETFs and LICs and why I like them both, here are the four factors when I consider my purchase. They are not necessarily in order of ranking, but this is the order I generally look at it.
- Whichever LIC has the biggest discount to its value out of AFI, MLT, BKI or ARG, using published NTA or NAV figures and interpolating for the index performance or using Pat the Shufflers interpolation spreadsheet. Remember that some LICs consistently trade at a discount to value, which means the ‘market’ isn’t ‘favouring’ them now and if the business and management is solid, then your getting a good deal. One thing I look at is what I call the discount delta, which is the current discount to its regular discount rate. For example if it regularly trades at 1% below NAV, and today its trading at 2% below NAV, then it has a discount delta of only 1%, as compared to its discount of 2%. Compare the discount or the discount delta to other LICs or ETFs to get an idea of it looks relative to the market. If no LIC is trading at a discount I go to step 2.
- Whichever ETF out of A200, VEU or VTS has gone down the most. Yes if the ETF has gone down that means its underlying holdings have gone down. Yes, sometimes this is linked to reduced dividends but history tells us most of the time that dividends are not explicitly tied to capital value of shares. In a market crash the business fundamentals of most companies don’t suddenly change, i.e. telcos still provide mobile phone contracts, people still buy food and use electricity. This means the companies continue to make profits and therefore the diversified dividends from ETFs (and LICs for that matter) don’t decrease the same percent as the share price drops (as the share price is mostly determined by greed or fear, whereas the profit/earnings of those companies are determined by solid business fundamentals). Therefore whenever I see RED and an ETF has gone down, in my mind I see a more attractive P/E ratio and a chance to buy future dividends at a discounted rate. If none of the ETFs have gone down, I look at whichever has gone up the least!
- If everything is still tied, I tend to buy Aussie shares due to the higher dividend yield (which makes it easier to live off rather than having to time the market to sell shares) and of course the franking credit refunds. I buy the ETF which has the lowest management fee, and at the moment this is Betashares A200 ETF.
So there it is, a rough breakdown of my investment strategy. Currently these are all invested in a personal name, but due to recently reaching my threshold portfolio passive income amount, I am planning to eventually sell them all and transfer the wealth into a family discretionary trust structure. This is a more tax efficient structure as a discretionary trust can allocate portfolio gains into family members on lower tax brackets – once this tax savings offsets the administrative cost burden of the trust, its a no brainer.
Benefits to my Investment strategy
Benefit 1: Emotion
By Dollar Cost Averaging, I remove the emotion factor whilst investing. When I was saving up cash, and indeed when I had a lot of cash sitting around which I had planned to use to buy a property and pay off most of it initially, investing it at times felt a bit gut wrenching. I was terrified the market would drop right after I bought it, and seeing the market grow higher and higher every day before I invested it didn’t feel any better. Dollar Cost Averaging is a way I have removed my personal fear and bias from the equation, and simply every fortnight make my regular investment decision and don’t look back.
Benefit 2: Cost base
By Dollar Cost Averaging a set amount each fortnight, in the long term I buy shares cheaper. This works because if the market rises and valuations increase, my $3000 buys less shares that fortnight. Conversely, if the market drops and valuations decrease, my $3000 buys more shares that fortnight. Overall, when you consider the cost base per share, you buy more shares at a lower price than you did for the higher price – so you get your best value for money overall.
Benefit 3: Diversification
By splitting my purchases between 8 different ETFs and LICs over Australian, US and global markets, I rest easy at night knowing I have a wide range of diversification at a rock bottom price. Whilst some of the Aussie ETFs and LICs do overlap, there is a different reasoning behind including them in the structure.
This means for me to lose all of my money, thousands of globally recognised companies would all need to collapse – still an option, but statistically insignificant. I daresay if this happened I would probably be more worried fighting off the zombie Apocalypse or finding my place in a new world order.
Benefit 4: Franking credits
Having the majority of my funds invested in the Australian market might seem like a classic case of home bias, but the franking credits are just too juicy to pass up. Especially for someone chasing FIRE, where dividend yield and tax efficiency are two major factors in quickly growing a portfolio that you can live off. More information on my post specifically about Aussie shares and Franking Credits
Benefit 5: I never need to know when to sell
With a buy and hold strategy, I never need to know when to sell. I have a smartly diversified holding of thousands of constituent companies, all being reevaluated and rebalanced for me. I never need to ever worry about getting the best price for a sale, I just sit back by the pool and sip cocktails from a coconut whilst the dividends pour in (ok maybe not the coconut thing, but you get the sentiment). This also cuts out a huge amount of money people waste on brokerage by constantly stock picking and buying/selling.
Benefit 6: Value
By purchasing a LIC at a discount or discount delta, I realise an instant profit by buying something at a price below its value. Similarly, by buying an ETF that has gone down, I am buying stocks that have gone down in value, and therefore by definition which have a higher Earnings per share or better P/E ratio.
Benefit 7: Management fees
By only buying ultra low fee ETF and low fee Index funds, I am paying bugger all in portfolio management fees. Even with my fatFIRE target of $1M, I would on average be paying a MER of .1% or $1000 per year in management fees. You’d spend more every year if you went out for a $100 dinner once a month!
Benefit 8: Free portfolio tracking
Because I have less than ten holdings, I qualify for a free Sharesight online portfolio tracker. This is an awesome online program which tracks all of your purchases and dividends (and sales too if your so inclined) and can spit out a tax summary at the end of the financial year to hand to your accountant.
Less than ten holdings, but own thousands of international ‘blue chip’ quality stocks? Yes please. I still have two placeholders to spare so I can gamble on a tech startups and a marijuana stock if I really want to (haha not likely though!). Even if sharesight went bust or started charging a premium, I could easily resort to manually printing the 8 tax summaries from the share registries and doing a bit of math over a few hours, but whilst I can get it for free I will!
I hope you got something out my investment strategy, and that you might be able to implement it yourself or tweak it into your investment strategy. If you have a different strategy or another way of looking at things, let us know in the comments below!
My investment strategy addendum part 1
Due to the lower management costs, I have decided to stick with only Vanguards VTS for buying US shares, and Betashares A200 for buying Aus shares. I still hold IVV (US) and VAS (AUS) however I won’t be adding to them.
For some reason I had it in my mind that it would be good for ‘diversification’ but it seems more like an ‘annoyance’ on my balance sheet as I don’t think any of these funds will be ‘going bust’ anytime soon.
I am in no rush to sell them, however if the opportunity presents itself I may do so and put the proceeds into the most attractive investment at the time – either an ETF (A200/VTS/VEU), LIC (AFI/BKI/MLT/ARG) or the property development.
My investment strategy addendum part 2
Without wanting to sound like I ‘timed the market’ I noticed the other day that IVV shares had a higher percentage gain than VTS, and similarly VAS also had a higher percentage gain than A200.
I’m no financial expert but I reasoned if both of those funds hold similar underlying shares, then that meant it would be a net gain to sell my IVV and VAS holdings and buy into VTS and A200.
Since I wasn’t adding to IVV or VAS anyway, and I had a couple of free trades from SelfWealth, I decided to move the capital into the funds with the cheaper management fees. Ultimately we can’t control the market, but we can control the fees we pay along the way!
My investment stretegy addendum part 3
When researching whether any LICs were trading at a discount so I could snap them up during this Coronavirus pandemic stock market panic, I noticed that two of my LICs – AFI and BKI were both trading at HEFTY premiums to their NTA. like in the order of 8% or something.
Accordingly, I ‘timed the market’ and sold them, putting the money into the A200 ETF which always trades at fair value. Because I had technically ‘lost money’ on this trade, I didn’t pay any tax and got some capital losses to carry forward if I ever do realise a gain.
For some reason LICs tend to trade at a premium during bear markets, so once the market recovers they should start trading at a discount again and I will continue to buy them as per my investment strategy.
Get Financial Independence!