Strategic asset allocation and investment plan for CaptainFI’s journey to financial independence.
It is important that in your pursuit of Financial Independence that you set yourself goals, decide on an investment strategy including strategic asset allocation and then keep yourself accountable to it. Smart investors educate themselves, and set to investing regularly on their path to financial independence. If you can automate it and take yourself out of the loop – even better.
This article goes into great detail to explain my personal investing framework – my financial goals, strategies and how I plan to keep myself accountable. I discuss the pros and cons of my strategy, and how it has evolved over time with my lessons learned from the many mistakes I have made. This predominantly talks about my share market investments, but I also have investments in real estate, online businesses (websites), superannuation, and an annuity (a type of fixed income insurance product).
- Passive, requires little to no investment knowledge
- Lowest possible cost portfolio
- Historically the best long term risk adjusted strategy for wealth creation
- Can be fully Automated through Pearler
- Full international diversification
- Shares protected through CHESS sponsored broker
- Tax effective dividend yield thanks to franking credits
- Reliable dividend yield for income (retirement phase)
- Ideally need to rebalance yearly (if not automated)
- Slightly higher brokerage costs over an ‘All-in-one’ fund
- Higher risk due to shares – long investing time frame needed
- Cash-flow from dividends yield not as tax optimal for FI than capital growth strategy for the accumulation / growth phase.
- Ease of access to portfolio makes it tempting to tweak and change
Verdict: CaptainFIs ETF portfolio is built using target of 25% A200, 50% VTS and 25% VEU
Introduction to Captain FI’s investing strategy
Since my investing strategy has evolved over time, looking back over it somewhat comically I do have a laugh about how much I unnecessarily over thought and over complicated some aspects of it initially. Because seriously – reaching Financial Independence is quite simple: Find innovative ways of earning more, carefully spend only on the things that you really need (and on things that you love and that brings you great joy and value), and then invest the difference in broadly diversified funds – making sure to leave them alone to compound and of course to regularly add as much as you can. When you reach your ‘FI number’ or passive income threshold, voila!
In the interests of sharing how I learned and evolved, I have still included what I have done historically however also included notes and commentary about why I no longer do that or why it didnt work for me.
It is important to realize that this is just my musings on my particular investments, and what I do doesn’t automatically make it right for you or your circumstances. You shouldn’t just blindly copy what I do and you need to do your own thorough independent research (including reading things like the PDS), and consider holistically your financial needs such as risk tolerance, investment time frame / horizon, emergency funds, insurance requirements etc. If its starting to sound complicated and overwhelming – think about going to see a licensed financial advisor.
Building your Investing strategy framework
Before you start investing, you need to understand your ‘Why of FI’ and your motivations. This will help you develop your own personal investing framework. I started by looking at my goals and dream life, and then trying to reverse engineer what I needed to do to make it happen.
Once you have an idea of what you might need, such as determining your ‘FI number’ or how much passive (or semi passive) income you will need, you can then set about how you can make it happen and determine your strategy, as well as how you will stay accountable and motivated in this journey.
Before you can start developing your investing strategy you need to make it very clear in your mind why you are doing this in the first place. You might want to build a nest egg for your retirement, pay for your children’s education, drop down to part time work or you might just want some extra passive income to cover your future lifestyle costs. It is important to start with why, because this will frame your entire investing strategy, keep you motivated on your journey and let you tease out your goals and ultimately know when you have achieved them.
Captain FI’s investing Goal
My personal goal is to reach financial Independence (FI) so that I can start a family without the stress of having to work – or more to the point, without the stress of having to make the choice between my professional and personal life. I want to be a ‘work optional’ devoted father, and be able to focus all of my energy onto this amazing and very ‘all-consuming’ project.
I think I should provide some context for you – I worked a lot – probably too much. As a professional aviator I find myself fairly regularly working 80+ hour weeks – sometimes I spend weeks and even months away from home at a time. There is a lot of expected overtime to be flown as well as professional development, ongoing study and sim assessments to ensure we are exceeding the baseline flight safety and performance standards. I am usually bouncing right up against my maximum crew duty limits (the maximum amount you are legally allowed to fly in a set time period).
I know this will be extremely challenging to juggle as a parent, especially with a larger family (I want lots of kids!). I have seen this high workload negatively impact some of the dads I have worked with. Some end up letting their work life balance suffer and in the short term give up sleep, hobbies, sports, recreation, friendships and relationships, and even accept a lower standard of workplace performance and ultimately this leads to higher stress and poor health.
Many of the pilots I work with have strained relationships with their families and children, and I would even put it out there to say that there is a much higher rate of break-up / divorce and dysfunctional families among pilots than in people with other professions.
So I want to be ‘work optional’ and perhaps choose to fly on my terms so I can prioritize my family – maybe not at all when I have a newborn, and then later I can fly part time on a reduced roster.
Captain FIs Investing Framework
Ultimately, the framework is built around my projected cost of living in retirement and then trying to build passive income around this number.
My cost of living
I live a fairly moderate lifestyle, and so my ‘Single FI’ number is around $2000 per month ($24,000 per year just for me, renting a very modest accommodation). This means to sustain me forever according to the generic FIRE 4% rule, I need to buy and hold a portfolio of around $600K, plus about another $40K to account for the tax payable on that passive income for a total of approximately $640K.
When family comes around, I have worked out I would need another $600 per month per child, and thus want to hold around about another $100K of investment assets per child – for 6 kids this means the portfolio is now up to $1.24M!
I want to buy a decent block of land to raise my family on, and eventually have enough passive income coming in where I can support my family and focus on living a ‘semi-homestead’ style of life where I can grow a wonderful, large garden and orchard, and focus on permaculture, sustainability and self-sufficiency. Realistically, this land might cost me somewhere around $300K or a mortgage of around $800 per month with a $60K down-payment. To be honest, this is pretty optimistic, and a decent sized block of land anywhere near a capital city is going to be way more than this.
When I account for the costs of the property and additional taxation that the portfolio must pay (remember we have to declare portfolio profits as income and it is subject to taxation), working backwards the portfolio would need to generate about $7K per month (before tax), for an after tax figure of ~$5500 per month, making my ‘Family FI’ number $2.1M according to the 4% rule!
Of course, there are some unique perks, tools and concepts I can use when starting to plan and structure this strategy to get this down to a more ‘achievable’ number.
The effect of Superannuation
One of the unique tax retirement structures in Australia is superannuation or simply called super. I have a great retirement package with my previous employer and I have made additional concessional (tax reduced) payments into the scheme over my working career so it makes up a decent chunk of my net worth.
My Super provides me with the options to take a lump sum at preservation age (handy for paying off outstanding mortgages, or buying more index funds?) as well as an ongoing annuity (pension) for the rest of my life which is obviously a huge part of my investment strategy and retirement planning.
So whilst I am being mindful with my side hustles, saving and investing to build the ‘FI Portfolio’, I know that it doesn’t need to last me forever (which is what the 4% rule from the trinity study is based on). If I retire in my 30’s, my portfolio only needs to last 25 years until I can start to access some of my super benefits.
This means I could actually drawn down the portfolio at a much higher rate – even over double the 4% rule could still work! I ran some figures with online calculators and in excel and have chosen to use a 7% ‘FI withdraw number’ as a starting point, and that this might safely last me according to my calculations (far too many spreadsheets and projections) according to my risk tolerance.
To make $5500 per month after tax, or approximately $7000 per month Gross, using a 7% withdrawal rate means I only need a ‘Family FI’ portfolio of $1.2M – which means it is starting to sound much more manageable!
Diversification, flexibility and risk tolerance
Market crashes early in FIRE could negatively affect this (the first few years would have the most impact – Sequence of Risk Return), but I also plan to have some diversified streams of passive income as backup; some from index funds, some from my businesses and some from property.
If a serious market correction occurred and cutting back on expenses wasn’t enough, I could always pick up some part time work aka Barista FIRE! This would supplement my emergency fund seeing the bear market out until dividends and portfolios improved.
I could draw on the emergency fund which is attached to the investment property offset account, and I also plan to set up a HELOC (Home Equity Line of Credit) style account such as NAB equity builder against my PPOR. This will provide ‘dry powder’ to be able to potentially take advantage of cheap shares in the crash – a strategy sometimes called debt recycling which is explained well by Pat the Shuffler on his blog The Life Long Shuffle. It sounds confusing but using the HELOC, you could also technically just ‘live off’ some of this equity to supplement your emergency fund, but its not that simple and there are lots more things you need to consider.
I also have other income streams including rental income from a positively geared investment property, and also semi passive income from online business which runs a portfolio of 18 websites – Both of these reduce my reliance on the FI portfolio, and ultimately improves my factor of safety and reduces the risk of portfolio failure before super.
Family estate planning and trusts
I don’t plan on raising a family on my own. Accordingly, my future partner and I will be able to jointly hold some of our assets in each of our own names, as well as receive distributions from the family trust. This means that the first $18.4K each of distributions is tax free, or nearly $37K combined.
This reduces the taxes payable on the FI portfolio income down to just over $35K, and because this is split between my future partner and I this echelon only be at the the first tax tier of 19c in the dollar (instead of me paying it at up to 32c in the dollar if it was all in my own name or solely distributed to me).
Instead of paying $18,500 in tax per year on the $84K the portfolio makes, and only taking home $65K (~$5460 per month), this brings the tax bill down to a more manageable $5200 each or $10,400 total. This saves over $8000 in tax per year – cutting the ‘Big Family FI’ portfolio requirement down by over $114K worth of investments using the newly adopted “7% rule” guide.
My FIRE numbers
Using this framework means I would only need a $365K portfolio for ‘Single FI’, or about $1.1M for ‘Big Family FI’. Of course, these numbers are not the goal themselves – they are just representative of a passive income threshold which is the actual goal. Nonetheless, they form an interesting metric and a method of tracking my progress to ‘FIRE’ (but the best metric is on ability to generate passive income rather than Net Worth).
This covers a pretty decent time-frame and I am sure there might be some legislative changes (and maybe even a further 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 figure I’m happy to continue flying and earning for a little longer after I hit my ‘FIRE’ numbers.
I am flexible, and currently weighing up whether flying full time or part time work arrangements would be appropriate with a young family. 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!
As I transition from the accumulation (growth) phase to the retirement (draw down) phase, I will also be looking to ‘switch’ capital from being locked up in investment properties into higher cash-flowing assets like stocks. The HELOC is one way of doing so – debt recycling makes the non-tax deductible mortgage interest on the farm into a tax deductible expense and thus lowers the tax bill a bit and increases the cash flow. Refinancing with interest only loans for the IP is another strategy to extract equity, and the remaining capital equity and cash flow forms additional passive income and a bit of a hedge against superannuation to reduce overall financial risk later in life.
Update: I Pulled the pin and ‘FIRE’d’ in 2022 – I didn’t have this much invested directly into just ETFs (approximately $800k), but the overall Net Wealth was approx $1.8M due to other assets and I had passive income sources which covered my projected expenses.
How Captain FIs investing strategy evolved
Personally, I use what I think is a fairly easy and passive investment strategy when it comes to buying shares. I invest in a mixed portfolio of Australian and international stock and keep very little cash. The way I invest combines the four “conventional strategies” of Lump Sum Investing, Dollar Cost Averaging, Buy the Dip, and Buy and Hold Investing. This makes it easy for me to decide on which particular stock I will buy each month, based on the target portfolio and what is value at the time.
I also invest in cash flow positive property, and at one stage had been allocating roughly half of my savings into a property development (other half into shares). The plan is that in the future, I will be able to access the manufactured equity from the development by refinancing, and using that equity as the down payment on the next development or investment property until I max out my serviceability to acquire cash flow positive real estate for passive income
Finally, I have also been investing my time and some money into developing and building online businesses and websites (just like CaptainFI.com) and have a portfolio of websites which will ideally grow and generate relatively passive income through advertising, affiliate marketing and digital products (such as ebooks and courses).
I aim to keep myself accountable in a few ways, one 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 proven 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 what’s really important is 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
It’s 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 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 it’s 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 ETFs 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 you’re 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
It’s 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.
Captain FI’s first attempt in the stock market
My first attempt in the stock market involved me trying to pick stocks according to tips from the Barefoot Blueprint.
Whilst it was kinda fun initially and exciting reading about companies and following ‘Buy’ and ‘Sell’ signals, this did not end well as it ended up becoming a lot of work and I underperformed the index. I sort of realised if you are following stock tips and ‘Buys’ and ‘Sells’ newsletters, then really you are just a sheep following someone elses ideas and orders.
Unless you actually know when to ‘Sell’ a stock, you are stuck on tender hooks waiting (and paying the whole time) for the ‘sell’ signal to come out. And I kept reading that shouldn’t our investment horizon be decades for shares, so why are we buying and selling so frequently with a trading strategy?
Then Scott Pape came out with some gems regarding index funds, the ‘Breakfree portfolio’ and the ‘Idiot Grandson portfolio’ with the barefoot investor index funds.
Captain FI’s First attempt at a Financial Independence Strategy
I will start this with a caveat that I no longer use this first attempt at a FIRE strategy. As I learned my investment strategy evolved and I realised it didn’t have to be this complicated. Nonetheless, I still decided to include it for historical purposes and to show you how over complicated I made it for myself in the hope you will not make a similar mistake of overthinking investments.
My first attempt at a FI strategy was trying to combine all of the above. All I do is make a regular investment decision on which index funds to purchase and hold (ideally forever). That’s it – Easy as ? And it took about 5 minutes every payday.
If I receive a windfall, I’d 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! What I learnt from the Vanguard and Morningstar papers was that mathematically, the sooner you invest the money, the better. This made sense and agreed with the statistics courses I did at university for my engineering degree – however you do have the human emotion factor to deal with and there is always the risk of a market crash right after you invest. Nonetheless, I try to use my head rather than my emotion on this one.
Also, rather than buying a set amount of shares every month, I decided to allocate a set amount of money. This is a way of helping to budget and automate my investment strategy which has awesome psychological benefits. The majority of this investing money came from my job working as a pilot, but I also reinvested income from my passive investments (i.e. dividends from the portfolio) as well as that from some side hustles (such as building, selling and operating websites, eBay selling and T-shirt sales).
Initial Target Portfolio asset allocation
In terms of which assets and index fund I buy, I initially split my purchases across 3 different markets. This includes Australian, US and international shares, with a focus on Australian shares due to their high dividend yield and franking credits (and maybe a bit of home bias, too!).
- Australian shares – Target 25% (currently 25%)
- American shares – Target 50% (currently 50%)
- International shares (Asia, Europe and emerging markets) Target 25% (currently 25%)
The idea was it would help me take advantage of “Value investing” as I could buy whatever was ‘good value’ at the time – if that market has dropped I could ‘Buy the Dip’ and boost that part of the portfolio back up to the target splits while avoiding paying a premium for a market that has just ‘boomed’. It also means I got to roughly maintain my splits and didn’t have to adjust my portfolio by selling, so it is tax effective in that I don’t need to realise capital gains. Of course, after ‘FIRE’ I still planned to conduct annual asset allocation which might include selling portions of shares if they have really boomed to bring the portfolio back into balance.
Captain FI’s initial investment vehicles
Specifically, I invested in Exchange Traded Funds and (previously in) Listed Investment Companies 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.
You can see my monthly Net Worth updates to see what is exactly in my portfolio over time, but these were the main ones;
Exchange Traded Funds – ETFs
- 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 Listed Investment Companies – LICs
- 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 BKI with its MER of .17% over the VTS with its truly amazing .03%. This is a valid question, and the reason I was initially attracted to and included some of these LICs was 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 Shuffler’s LIC discount spreadsheet – seriously awesome work Pat!
This means that although you’re paying a higher MER, you might be able to snag a discount and buy the LIC at 1 or 2% under its fair value. Let’s 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, it’s 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 something like 40 years of management premiums. Although its not really that simplistic.
At the risk of ‘market timing’, I could also potentially profit off of the fluctuations in discount and premiums to NTA – for example during the COVID-19 market downturn I sold one LIC when it traded at a nearly 10% premium to its NTA, and then just bought an ETF which should always trade at fair value due to the market maker. Yes I ‘lost money’ on paper and crystallised a loss (to carry forward and offset future gains), but as I effectively immediately reinvested it into the same market, I did not lose out in the long run.
ETF or LICs?
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 (company) 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 predictable (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 if companies drop out of the index and get sold (Which is why there is a balance to be struck regarding cost and the size of the index i.e. top 300 companies vs top 2000 companies).
LICs on the other hand employ a fund manager to pick stocks on your behalf. 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 and can be more tax effective and distribute more franking credits.. Their portfolios mostly mimic the index with the ability to deviate away from some of the larger speculative sectors such as mining or resources and focus more in high dividend yielding sectors such as Industrials (manufacturing) and Finance (banks).
But it’s 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 style’ of dividend investing approach is quite tax efficient in Australia due to franking credit refunds and the unique nature of franking credit refunds in retirement.
‘Boglehead style’ of capital gains 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, which makes it more tax effective over the long term (since capital growth isn’t being taxed along the way like dividends are) but they are still exposed to the risk of ‘timing the market’ and volatility when they make the final sale – which can be gut wrenchingly terrifying.
So the LICs provide a great product with reliable, increasing and tax effective dividend stream (some with Dividend reinvestment options or even Dividend substitution Share plans or Bonus Share plans). These dividends aren’t really as affected by market fluctuations as capital (stock prices), and as well as the LICs have the ability to be purchased at a discount to NTA sometimes..
So which investments did I choose for my first strategy?
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 Shuffle’rs 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 you’re 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 it’s 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 if 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 or is the furthest from my ideal split. 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 tied or I can’t make a decision, 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) as well as foreign exchange rates (the Aussie dollar is low at the moment so it buys less overseas funds) and of course finally the franking credit refunds. I buy the ETF which has the lowest management fee, and at the moment this is Betashares A200 ETF.
Benefits to my initial FI strategy
My FI investing strategy is pretty easy for me to use, and provides me with a number of benefits;
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. 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 ‘Big Family FI’ 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 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 you’re 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 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!
Summary of my first investment strategy
So there you go. A pretty confusing, jumbled mess of me trying to make sense of investing, trying to track the markets and manually buy whatever was on special at the time to get the most value. Not that it didn’t “theoretically work”, it just wasn’t very time efficient and I actually ended up still negatively influencing my purchasing decisions as I let media influence me and when I made manual purchases. I’ve actually vastly simplified how I invest these days, and I talk more about this in the addendum down the bottom of the article.
How I track my investment portfolio
The beauty of index funds really lies in the fact that a handful of holdings can literally give you global diversification to not only every single blue chip stock, but also small caps and emerging markets. But luckily you don’t need some crazily complicated spreadsheet that tracks thousands and thousands of companies. I started using Excel spreadsheets to track my index fund holdings, but it quickly became an unwieldy beast and overwhelmed me.
I discovered Sharesight, a free accounting tool. Finance professionals and companies often use a paid Sharesight subscription to help them manage massive amounts of data (such as multiple client portfolios etc), but for you and me, we can use Sharesight completely FREE because we have under 10 holdings.
The free account is more than enough for the average person, but you can upgrade to a paid subscription which gives you some more features.
Check out my detailed review of how I use Sharesight to manage my index funds, or Captain FI readers can actually get this bonus sign up offer which gives you four months of premium for free if you do upgrade.
Changes to my investment strategy and strategic asset allocation
Because we are all human and learn, I have included some of the big changes I have made to my investment strategy and strategic asset allocation since I first started investing. It is quite interesting to see how it has evolved over time.
My investment strategy addendum part 1 – 2018
Due to the lower management costs, I have decided to stick with only Vanguard’s 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.
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.
Let me be clear through, they are all pretty much fine and I would be equally as happy holding them and really I am splitting hairs here to just simplify my portfolio.
My investment strategy addendum part 2 – 2019
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 strategy addendum part 3 – 2020
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.
I found out that for some reason LICs tend to trade at a premium during bear markets (perhaps the more stable dividends and their cash holdings seem attractive?), 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.
My Investment Strategy addendum part 4 – 2021
Interestingly, I recently reviewed all of the trades I made with SelfWealth over 3+ years, and found that despite my best efforts I could not stick to my Enhanced ‘Dollar Cost Averaging’ investing strategy. My Human brain let me down, and caused me to hesitate whenever the market went down, and to rush in whenever the market went up due to FOMO. Exactly the opposite of what I should have been doing!
I consider myself pretty well educated and fairly disciplined – several postgraduate qualifications, started and run several businesses, years of investing experience and a Net worth over 7 figures – yet somehow I was unable to stick to an EXTREMELY BASIC investment strategy. Call it the human condition? So hence, I have stopped manually buying shares through Selfwealth, and have let Pearler Auto invest take over and simply debit my bank account each fortnight.
I initially set a portfolio asset allocation (in shares) of 1/3 Australian shares, 1/3 American shares and 1/3 Global shares (ex US) using the A200, VTS and VEU ETFs
My Investment Strategy addendum part 5 – 2022
After leaving full time flying, I did have a bit more of a hard think about asset allocation. I still use the same automated principles, but have shifted towards a target goal of 50% US shares, 25% Australian shares and 25% Global shares (ex US). I have considered switching to the ‘two fund’ portfolio using just VAS and VGS, or even the single fund VDHG or DHHF portfolio, however I am still pretty happy with the three fund split and I don’t really want to realise any capital gains if I don’t have to.
I hope you got something out of my investment strategy, even if it was just a laugh at my first attempt at stock picking following newsletters, or the hilariously complicated manual first FI strategy. I hope that it provides some insight into my journey and the power of simplicity and that you might be able to take the lessons I have learned the hard way and somehow use that for your learning when you make your own choices about your investment strategy. If you have a different strategy or another way of looking at things, let us know in the comments below.
Captain FI is a Retired Pilot who lives in Adelaide, South Australia. He is passionate about Financial Independence and writes about Personal Finance and his journey to reach FI at 29, allowing him to retire at 30.
11 thoughts on “Captain FI’s Investing Strategy and Strategic Asset Allocation”
Thanks for your post. Regarding your comment about LICs being more smooth and predictable, perhaps one may consider transitioning from ETFs to LICs as they get older or get closer to retirement age, as one would consider moving it in to cash/bonds (but not as extreme)? It would also be interesting to know your thoughts concerning Salary Sacrificing in to your Super, albeit being diligent to do so under the concessional contributions cap. I agree that you should limit to 5% as my understanding is that this is all the employer matches
You raise a great point when it comes to removing emotion from investment – this goes in to trying to time the market on both the ups and downs. Just put the money in when you have it! This can also be mitigated by only allowing yourself to check your portfolio once every week or month (instead of daily, however tempting).
In terms of diversification – the big caveat (and downsides?) with investing in ETFs is being able to have the tolerance and time to allow a market to recover (~5-7 years). This isn’t a strategy for people who are after a quick buck.
I’m at a bit of a loss to even say which is better, I definitely enjoy holding both LICs and ETFs for their awesome benefits. Whilst LICs typically suit the Thornhill style ‘dividend yield’ investing focus, some of the aussie ETFs like VAS even produce a significant and majority franked dividend yield (VAS is 87% franked) that exceeds some of the LICs. For example sticking with VAS, last year it produced 4.26% dividend, with 87% franking for a roughly 5.29% gross yield against the four LICs grossed dividend yield of AFIC: 6% BKI: 8.8% ARG:5.7% MLT: 6.6%. Its worth noting that this is comparing dividend yields only, and total return for VAS since inception is 9.8%, against the LICs total return AFIC: 10.9% BKI: 10.4% ARG:10.8% MLT: 9.84%. The choice for me is not whether which style is better or not, I just try and buy them all in line with my investment strategy. I figure it doesn’t hurt and the only downside I can really see is maybe having to handle 9 bits of paperwork once a year at tax time versus what could probably be pared down to 3 (A200, VTS, VEU). But sharesight does all that for me anyway.
In terms of super – I used to do a concessional sacrifice to my cap of $15,000 per year, however I realised that I would much prefer to have that money NOW than MAYBE get it when I reach my preservation age. I just don’t trust the government with their hands in our honeypot of superannuation, and to be honest, I want to live off that money between when I Get FIRE’d at 30 (or thereabouts) and when I can access the rest of my super. Yes salary sacrificing into super is tax effective – you only get charged 15% tax instead of the marginal rate of up to 45% (for earners above $180K), but the reality is that most earners are probably on the 32% bracket, meaning salary sacrificing the full $15,000 is likely to only save you around $2550 per year, but the $15,000 is going to allow you to reach FIRE much much sooner if it is invested in your Get FIRE’d! Portfolio.
100% investing needs to be logic and fact based, and emotion can be very dangerous, especially in a market downturn. I guess we will see what happens and if we can stay true to our strategies if it happens! Removing the broker app from my phone was the BEST thing I ever did, and now I only check it once or twice a fortnight when I am positioning myself to make the fortnightly investment decision.
As for your point about a quick buck – absolutely this is a long term game, and if you want a quick buck maybe head to the local casino and stick it all on black! Or follow some instagram hustle accounts for hot stock tips on what to lose your money on.
“I split my purchases across 9 different index funds”
u wot m8
LICs are NOT index funds. An LIC are actively managed (exact opposite of an index fund). LICs have people are paid to pick stocks, which is exactly the reason why they will underperform the index.
Ps. Think it’s funny that your “super simple strategy” contains NINE funds, and involves checking LIC NTA values in order to pick what to buy…
TL;DR – yes I am shifting more towards a core principle of a 3 way split A200/VEU/VTS
Hi Zdamant, first of all I wanted to say thanks heaps for the comment and I’m sorry I couldn’t get back to you earlier! I’ve had a heap of shit going on. Rest assured though, I have taken it to heart. Your 100% right there, LICs are definitely NOT pure index funds and I’ll need to be a little more careful and less blazé with my wording. What I meant to convey is that like an Index fund, from my perspective, they are passive. With some of the older ‘grand daddy’ LICs such as AFI, MLT etc that I own, they actually have super low fees – high fees is one of the reasons I wouldn’t own a conventional managed LIC. Secondly these granddaddy LICs don’t tend to stray too far from the formula if you catch my drift. They tend to achieve close to the index but I tend to agree with you mate – the tinkering of the index would tend to cause them to underperform. There are however some tax benefits and dividend smoothing benefits due to their unique closed ended trust structure which makes them appealing. I’m far from an expert and there are some amazing blog articles written by StrongMoneyAuatralia and TheAussieFirebug on this exact topic. As for the ‘super simple strategy’… it’s the best I’ve got at the moment! 😅 I think the core of the strategy is simply a split of A200/VEU/VTS which is what I am mostly doing, however I do like to tinker by involving the Aussie ‘grandaddy’ LICs as I feel if they trade at a discount there may be opportunity to ‘value invest’ or be ‘greedy when others are fearful’ as Warren Buffet would put it.
How do you work out the NTA discount delta? How do you know what the LICs “usually” trade at?
We have a similar strategy to you – a bunch of old LICs plus a couple of index funds, so I’m curious about the discount delta rather than just the discount.
Its not really an exact science. I just try to see what the historical discount to the NTA is – for most of the LICs they actually publish this information as graphs on their websites under historical performance. Say one of them called ‘X’ trades regularly at 1% below NTA, then its trading at 2% below NTA today, I would say the discount delta is 1%. For a second LIC ‘Y’ that usually trades at a 1% premium, but is now trading at a 1% discount to NTA, then the discount delta would be 2%, I’m not sure how useful the metric is but I guess it just tells you how what ‘the market’ is thinking of that LICs management style today as opposed to whatever previous timeframe your looking at. In this situation, would you pick LIC ‘X’ or LIC ‘Y’? Personally I like that LIC X is 2% below NTA, which seems like a good deal and my take is that it might be able to produce more dividend yield (since the fund owns more ‘stuff’ per unit cost), but perhaps lic Y which is trading at a higher discount delta might be better for ‘short term’ capital growth since it historically has higher investor confidence? At the end of the day I dont really know, but personally I think I would lean toward LIC ‘X’ if it indeed is true that it would generate more dividend yield. I guess if a little from either doesnt hurt, and like you I hedge my bets with both ETFs and LICs
Thanks for explaining!
I think I’ll just stick with the current NTA discount, as it’s much easier to calculate and understand!
Interesting article for me to read as I’m getting my head around all of this stuff – thanks for sharing! I’m curious to know more about the “threshold portfolio passive income amount” you mention. How do you know what this amount is?
Hi Rebecca! Thanks for the question. I have completely revised the first portion of the article to make this clearer in how I arrived at my ‘FIRE’ numbers or goal setting for the portfolio. Check it out and let me know what you think! Cheers
I am retired and looking for a ” set and forget” type investment (4.2 mil) for my SMSF.(I do not need the income as I have property investments.)
I am intrigued by Australian LICs FGX and FGG.
I would value your opinion regarding these products.
G’day Tony, FGX and FGG seem like a novel idea at first sight – two funds, one run for dividend income and one for capital growth. 1% MER which is donated to charity and fund managers donate their time to run the funds. Looking at Sharesight returns over the past 5 years, these funds have under-performed the market and you would have done better to just hold an index fund. Probably something to do with that 1% MER. I think its an over complicated structure. If you want to donate to charity, why not just donate to charity? You can even claim certain charitable donations against your tax, meaning a $1 donation costs the average punter 70c or something – or conversely you could donate $1.30 instead for the same effect. I would keep it simple mate and focus your investing on investing and your giving on giving. Just my 2c – not advice of course, but I personally won’t be investing in FGX or FGG.