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Financial Independence Retire Early

Vanguard Diversified Index ETFs

Vanguard Diversified Index ETFs

*Nothing written below is financial advice. Always do your own research when dealing with your finances

One ETF to rule them all?

OneETF

The majority of the Australian FIRE community roughly subscribes to one of the three combos when it comes to ETFs:

  1.  40% Oz shares (VAS or AFI) 60% international (VGS or equivalent)
    • Pros
      • Great exposure to the entire world with enough Australian shares to take advantage of franking credits
      • Don’t have to fill out a W-8BEN form every couple of years
      • Hedged against the Australian dollar
      • DRP option available
    • Cons
      • Highest management fees (0.164% assuming the above weightings) out of all the three options (more on this later).
      • Have to manually rebalance
  2. 40% Oz shares (VAS or AFI) 60% international (VTS+VEU)
    • Pros
      • Great exposure to the entire world with enough Australian shares to take advantage of franking credits
      • Low management fees (0.101% assuming the above weightings)
      • Greater diversification than the other two options
      • exposure to emerging markets
    • Cons
      • Extra admin to fill out W-8BEN form (less than one hour every few years)
      • DRP option only available for VAS, not VTS or VEU
      • Potential estate issues when you die for VTS and VEU units
      • Have to manually rebalance
  3.  100% Oz shares – Dividend focussed (VAS or AFI) (Thornhill approach)
    • Pros
      • Take full advantage of our unique franking credit systems in Australia
      • Dividends are less likely to be affected during a downturn
      • Hedged against the Australian dollar
      • Don’t have to fill out a W-8BEN form every couple of years
      • Low management fees (~0.14%)
    • Cons
      • Not diversified outside of Australia
      • Miss out on international market gains
      • Capital gains traditional low for this strategy
      • Home bias

All three strategies have their merits but they all require rebalancing with the exception of an all Australian ETF. The issue with that strategy is, of course, you don’t have much diversification as Australia is only roughly 2 percent of the world economy. And with how much private debt Australians have right now… if Australia went through a recession the all Australian portfolio would not fare well.

The point is that each one of these strategies is missing something and require manual intervention whether it be rebalancing, extra admin work or more diversification.

Wouldn’t it be good if there was an ETF that took care of all this for you?

 

Vanguard Diversified ETFs

 

Vanguard Diversified ETFs

So what are they exactly and what’s the difference between buying this ETF vs one of the three options mentions above?

To put it simply, any of the four diversified index ETFs above offer a complete one stop shop solution for anyone looking to invest.

They solve a few problems that our three options above had

  • Diversification – Exposure to over 10,000 securities—in just one ETF.
  • Auto Rebalancing
  • DRP option
  • Hedged against the Australian dollar*
  • It wasn’t listed above as a con, but all four diversified index ETFs are actively managed using Vanguard Capital Markets Model (VCMM)

The two big ones that stand out are of course the auto-rebalancing but also maybe surprisingly the active management component.

Rebalancing is not hard to do, but it’s something that if left unattended can most certainly affect the performance of your portfolio over the long term. As for the active management component. You may be wondering why there is any management at all? I thought Vanguard is all about minimal management to keep fees low and it’s really hard to beat the index anyway??? I’m not sure about this part beating the market either but I guess we will have to wait and see how it performs. It uses a modeling system called VCMM to simulate potential outcomes and pick the correct balance for your desired portfolio out of the four options above.

VCMM

*As pointed out by Chris in the comments. The diversified ETFs are not 100% hedged. Please check the PDS for each ETF to find the amount of hedging

Who Is This Suited For?

To be honest, it’s a bloody good product for 99% of people. What they are offering here is as close to the perfect ETF as I’ve ever seen given the management fees and what it offers.

The best thing about this ETF is how idiot proof it is. A completely n00b could buy one of the four diversified ETFs (depending on their investor profile) for the rest of their life and get respectable returns with minimal effort.

People avoid things that appear confusing and hard. That’s why robo investment companies like Acorns and Stockspot are in business. They essentially are providing what this ETF is providing at additional costs because they make investing super easy and friendly. With the other three options listed above, it can be daunting to explain to a complete n00b how to rebalance. As soon as they don’t understand something, the majority of the time they can get spooked and give up altogether.

That’s why this ETF is so special. You can confidently recommend this product to anyone and be sure that they can’t stuff it up or get confused.

  1. Set up a broker account
  2. Buy this ETF when you have the money to do so
  3. Turn on DRP if you want
  4. Do tax when it comes around
  5. Repeat forever

So if this ETF is suited for 99% of people, who is the 1%?

 

Why I Won’t Be Switching To These ETFs

This is something I have been wanting to bring up for a while now.

Has the Australian FIRE community forgotten just how important management fees are?

I have been seeing a lot of people recommend VDHG, which as I have mentioned above is a fantastic product. No doubt about it.

The only issue I have is that at a MER of 0.27%, it’s more than double that of what my MER currently is (0.101% or option 2 above).  They are both very low fees, but I plan to have a portfolio of a million+ within the next 5 years and hope to live for another 50 years at least! Now even though the management fees are very low, over a long period of time it does add up!

I have actually been working on a web app recently (so close to being published) that works out lost investment potential from management fees which gives you a visual of what I’m talking about.

combo1

Management fees are unavoidble, but how much you pay is your choice to an extent. I have calculated my current investment potential loss from management fees to be $48K over 50 years at $1M invested.

If I change the management fees to be 0.27% we get the following

combo2

Holy shit!

We went from paying under $50K over 50 years in investment potential loss from management fees to over 5 times that amount at over $250K!

Ok, I need to clear a few things up about the above graphs because it’s a big deal.

What am I actually talking about when I say investment potential loss? I’m referring to how much management fees are costing the investor when you factor in that the money paid to management could have been invested and compounded at 8% return (that’s what the graph is using as a return rate).

If I had $1M in my portfolio with my current weightings I would be paying Vanguard $505 a year. If I had $1M with any of the diversified index ETFs, I would be paying Vanguard $2,700 a year.

The difference between $505 and $2,700 a year over a lifetime adds up!

 

Conclusion

If you’re reading this blog, odds are you’re somewhat interested in personal finance and investing. The question you need to ask yourself is whether or not you are willing to learn, educate yourself and do the extra things required for the lower MER ETF options. Or if you think that the higher MER for the diversified index ETFs are justified. I personally choose to keep my MER as low as possible because paying less in management fees is a guaranteed return. You could argue that the diversified index ETFs will outperform my ETF combo but that is unknown without a crystal ball.

If you don’t know what half of the words in this article are even about, then the diversified index ETFs are most likely the best ETF for you. Just pick your investor profile and off you go. And don’t sweat the extra management fees. If the simplicity of the diversified ETF gets you into investing, you’ve more than made up the difference.

Australian Financial Independence Calculator

Australian Financial Independence Calculator

There are countless sites/articles/forums about financial independence (FI) on the world wide web. I’ve often come across really clever, well developed calculators that offer a really good visualisation on how long you have to go before you reach FI. But the longer I searched for the best calculator the longer I realised that they were all geared towards other countries.

 

One of the main reasons I created this site was to offer my fellow countrymen quality information that was tailored for an Australian audience.

 

The biggest issue I had with every single one of these FIRE calculators out there was they didn’t factor in our Super system. The US system, which is the main system upon which I found almost all of the calculators accounted for, has a fundamentally different way their citizens can withdraw from their retirement accounts.

 

To put it simply, in the US you only need one portfolio to be at a certain amount before you are considered FI. But because you can’t access your Super before your preservation age (99% of the time) you end up with two. Your Super portfolio and a portfolio outside of it.

 

So what’s one to do? Do I just keep plugging away at my personal portfolio until I reach my FI number? That seems like a waste since Super has such a big tax advantage. You’re not likely to beat the 15% tax breaks on your Super.

 

But I don’t want to put money into Super because I want to retire young! And I won’t be able to touch the money until my preservation age (60 for me).

 

Decisions decisions decisions!

 

 

Introducing The Australian Financial Independence Calculator

 

 

Australian Financial Independence Calculator_2Australian Financial Independence Calculator

The above are two screen shots from the calculator showing the basic settings and the graph that it generates.

 

You will notice there are two lines in the graph. The Pre Super number is what you will be living off until you can access your Super. The Super number is obviously what’s in your Super.

 

In a nutshell, the most optimal way to reach FIRE here in Australia is to:

 

    1. Step 1. Have enough money to survive until your preservation age (when you can access Super). No matter how much you have in your Super, you won’t be able to retire early and pursue your other goals in life if you don’t have money coming in to live off. Step 1 is not meant to last you forever though. It’s only meant to last you until when you hit your preservation age and can then access your Super. You will notice in the above graph that your Pre Super number goes up and up and up…and then slowly tapers off past $0. This is by design. You want your Pre Super number to be at $0 when you access your Super.

 

    1. Step 2. Have enough in Super to cover all your living expenses forever! You will notice that the red line (Super) has a number of dips.

 

Australian Financial Independence Calculator_3

    1. The green part of the line indicates how much Super you currently have at the start. This will move slowly up (depending on how much Super you have) over the years as your super grows from compounding interest until you hit the pink arrow.

 

    1. The pink arrow indicates the time you have reached your Pre Super number. When you have reached your Pre Super number you theoretically should be able to live entirely off that number until preservation age (assuming all conditions stay the same). This means that 100% of your after tax income will be going into your Super account until you reach your Super Number.

 

    1. Your Super number is not actually your FI number. Your FI number will be reach in your Super account at the very start of your preservation year. But no sooner than that, because that is the most efficient and fastest way to reach FIRE. The calculator works out how many years it’s going to take you to reach your Pre Super number and then does some cool math and works out that you need a certain amount in your Super for it to grow into your FI number the year you can access it.

 

Pretty cool huh!

 

 

Video Of The Calculator In Action

 

Work In Progress 

 

The calculator has some flaws. It’s a work in progress. If you find a flaw please let me know and I’ll try to fix it.

Download Now

 

Enter your email address and not only will I send you the calculator. I will send you updated revisions of it ever time I fix a bug or the laws in Australia change.

 

Australian FIRE Calculator
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