We’re on track to increase our wealth by $100,000 dollars over the next 20 years by strategically changing the use of our home loan.
Not by taking on more debt.
Not by changing our asset allocation.
Not by increasing our risk tolerance.
2 transactions were all it took for us to start deducting interest repayments on part of our home loan.
This is a strategy known as ‘Debt Recycling’ (DR).
This article has been on my mind for a while but I really wanted to go through the process firsthand before writing about it. There are a few different ways to do DR but I’ll just be covering how we did it because I don’t know all the nuances with the other methods.
So let’s break it down!
What Defines Debt Recycling
DR = Turning non-deductible debt into deductible debt.
In our case, we wanted to be able to claim our PPoR (Principal Place of Residence) home loan interest as a tax deduction.
Without DR you can’t claim interest from your PPoR loan like you would with an investment property (IP) loan.
How We Did It
*Please note that all the examples in this article will be simplified. Things like rate changes throughout the year, loan repayments and when we officially started DR will remain constant to make it easier to explain.
For simplicity purposes, I’m going to explain our method of DR without our Family trust. I’ll add in the family trust later so everyone who does have a trust can see how we did it but I want to make it simple to start with.
IMO, DR works best when you have a lump sum that you’re planning to invest anyway. That was the position we found ourselves in after we sold IP2 and had over $200K in cash.
We also bought our PPoR last year and I was planning to DR part of our home loan so I made sure that we split it into two parts.
Here is how our situation looked before DR.
As you can see in the above picture, Mrs Firebug (Ladybug in the picture 😂) and I have to pay ~$10K of interest a year for both our home loans (which are secured against our PPoR). These are real numbers (sorry Melbourne and Sydney folk 🙈) when we first settled on our home.
We can’t claim that ~$10K as a deduction because the use of the borrowed funds were for our PPoR and not an income-producing asset.
We also have a lump sum of $211,000 from the sale of our investment property that we would like to invest.
For illustrative purposes, below is how it would have looked if we skipped DR and just invested our cash in shares.
Investing without DR
There’s nothing wrong with the above picture but the Firebug Family doesn’t save any tax on their PPoR home loans.
The point of DR is to change the use of the borrowed money for deductions.
We were able to change the use of loan 2 by completely paying it down and then redrawing it out to invest in shares.
This is how it looked after DR Loan2.
¹ Loan2 was paid down and redrawn to purchase shares. Loan2’s interest payments are now tax-deductible ² The Firebug family received $6,330 in dividends but can deduct $6,077 in expenses from Loan2 and thus only need to declare $253 in additional income.
As you can see in picture 2 we were able to change the use of Loan2 to become an investment loan.
We then used this new loan to buy income-producing assets (shares) and are now able to claim a deduction on the accrued interest saving a total of $1,975 on tax.
But how exactly did we repurpose the loan?
In one word… redraw.
Once we sold IP2 and had the large lump sum, I simply paid down Loan2 completely and then redrew it back out.
The above picture shows the balance for Loan2 to originally be $209,508.90 on the 9th of November 2021. I paid it down to $0 on the 29th and then used the redraw facility to pull the $209,508.90 back out straight away. Redrawing from a loan is considered new borrowings by the ATO.
I was very worried that the loan would automatically close so I went down to an actual branch to ensure that it didn’t. The girl that helped me actually knew what DR was which helped a lot.
And that’s basically it.
We essentially are in the exact same position we would have been without DR but now Loan2’s debt is tax-deductible.
How We Did It (With The Trust)
The concept of DR remains the same, it’s just more complicated with a trust. (like a lot of things 😅)
Here’s how we did it.
DR with a Trust
¹ You need to make sure that the terms of the loan allow for changes in interest rate to be the same as what the bank is charging you. In this example, it’s constant at 2.88% when in reality the interest rate would fluctuate. The loan agreement between the Firebugs and the trustee needs to be in writing and on arm’s length terms too. ² The Firebug Family pay and receive the same amount ($6,077) so their tax position is nill.
³ The distribution is only $253 because the trust had to pay $6,077 in interest to the Firebug Family. The distribution will be taxed at the marginal rate of the beneficiary.
There’s a lot going on in the above picture but I hope it makes sense. Leave me a comment below if you need something explained in more detail.
What If I Don’t Have A Lump Sum?
Not everyone will have a large sum of money to completely pay down a split of their loan. We implement a dollar-cost averaging strategy which means we don’t save up large amounts to drop in at once. The sale of IP2 presented a rare opportunity for us to execute our DR strategy but I understand that won’t be the case for most people.
Annoyingly, I actually had some examples and financial products that are suitable for people who want to do DR whilst DCA’ing. But since ASIC doesn’t let people like me talk about those sorts of things without paying them money, I unfortunately had to delete this part out of the article :(.
Terry W Tips and Future Podcast
I reached out to one of if not the best SMEs (subject matter expert) for DR in Australia for his top tips. I’m also teeing up another podcast with him to do a DR specific episode. Please let me know in the comment section what you want us to cover and I’ll try to add it in 🙂
If you want to know more about Terry, check out the first podcast we did together here. He also has his own podcast which you can check out here.
Terry’s top tips 👇
You can only claim interest if borrowing to buy income-producing assets
You need to avoid mixing loans as this will reduce tax savings
Split loans first before repaying
Repayment needs to be done once in full
Redraws can be done in stages
If borrowing to buy non-dividend paying shares the interest could be a cost base expense so it would still be worth splitting and recording the interest as it will reduce CGT.
Written loan agreements on arm’s length terms are needed if the borrower and the investor are different
Never redraw into a savings account with cash as it will cause a mixed loan
Avoid paying into a share trading account with cash in there as this will cause a mixed loan.
It is possible to debt recycle with any loan that has redraw, but some loan products are better than others, so see your broker about this.
Debt recycling is a tax strategy so only registered tax agents or tax lawyers can advise on it.
Advice on what to invest in would be financial advice if it involves shares or super as these are financial products so only an AFSL holder or authorized representative could advise on this.
It is possible to debt recycle with investment properties too.
It’s important to note that DR didn’t change our investments, amount of debt, asset allocation or anything else really. We simply changed the use of the borrowed money.
I used the 32.5% tax bracket but this strategy would save you even more money if you have a higher marginal tax rate (I forgot to include the medicare levy too which would have made the tax savings even more impressive).
There’s also a pretty good chance that interest rates are going to rise in the next couple of years.
More interest = more deductions for us.
Oh, and if you’re wondering how I came to that $100,000 number in the intro. I simply punched in $1,975 into a compound interest calculator for 20 years at 8 interest. There are a bunch of assumptions right there but it’s impossible to know how the interest rate will move over that time period and we plan to redraw equity out of Loan1 and Loan2 which will mean more deductions. Essentially, we don’t ever plan to pay off our PPoR loan. I eventually want to DR Loan1 and then continuously redraw equity for the foreseeable future (Thornhill style!).
This strategy is something that took less than a week to sort out but will be saving us money for as long as we have debt against our PPoR.
Pretty cool if you ask me 🙂
Are you doing DR? I’d love to know why or why not in the comments section below.
I started full-time work at the end of 2011 and discovered the concept of financial independence (FI) sometime in 2012 after reading Rich Dad Poor Dad by Robert Kiyosaki.
That book (and the concept of FI) changed my life.
It wasn’t until a year after reading that book that I stumbled across Mr Money Mustache and the FIRE movement, which again, changed my life.
10 years. That’s how long I’ve been chipping away at this goal. And a lot can change ya know. My mindset, goals, strategy, desires, priorities have all shifted throughout the last decade. I’ve been thinking a lot about the lessons I’ve learned throughout the journey. What worked? What didn’t? What’s the point of it all?
Let’s get it.
1. The ultimate goal is to be happy. Never lose sight of this
We’re starting this list with the most important lesson.
It’s a bit philosophical but it’s really important and it sets the tone for everything we do. Have you ever asked yourself the following question and really mulled it over?
“What do I want in life?”
Now, there are going to be thousands of different answers to that questions depending on who you’re speaking to but the common denominator will always be the same… a desire to feel joy/to be happy.
Going snowboarding is pretty obvious. That’s fun as hell! But going to the gym 3 times a week and lifting heavy shit is… less obvious. One involves instant gratification whereas the other is delayed by a series of uncomfortable painful sessions.
The driver and end result for both activities is still the same. To be happy.
This driver for happiness is behind nearly everything we do. But figuring out what sort of life is going to be fulfilling and bring us purpose is a personal journey. The sooner you identify the key drivers of your happiness, the quicker you can start to plan out your ideal life.
I know life sometimes feels really complicated and stressful but at the end of the day, we’re still just another animal on Earth whose needs and desires haven’t changed that much over the ~50,000 years we’ve been roaming around.
In 1943 an American psychologist called Abraham Maslow published a paper called “A Theory of Human Motivation” which included the now very famous Maslow’s hierarchy of needs.
Maslow’s hierarchy of needs
This hierarchy of needs is universal and transcends generations.
A spice merchant in Ancient Egypt 3100 BC would still need to cover each level on the pyramid (pun intended).
Start from the bottom and work your way up and don’t skip over the physiological needs either.
You’d be surprised how many people would feel 10X better by just getting a decent amount of sleep each night and eating the right foods.
How FIRE plays a part in helping you achieve a level of happiness can be explained better in lesson 2.
2. Find your why of FI
One of the biggest mistakes I have personally made and that I see all the time is people thinking that reaching financial independence will make them happy.
Spoiler alert. It doesn’t.
You need to find your ‘why’. Why do you want to reach FI? What will reaching FI mean for you? How will it make you happy?
Speaking from personal experience, FIRE resonated with me because whilst I quite enjoyed my job, I resented the fact that I was ‘stuck’ there 5 days a week. I didn’t like that feeling. And before I knew that FIRE was even a thing, I thought I was going to be in the cubicle for 40+ years 🤮
FIRE for me was about gaining more of the most precious resource we all have. Our time!
Free time is crucial for satisfying the top level of Maslow’s pyramid.
Money is just a man-made abstraction that doesn’t have any intrinsic value. We can leverage money to create more time and freedom in our lives. The most important part is knowing how to use this extra time and freedom to enrich our lives. Having a rock-solid ‘why of FI’ will help tremendously throughout your journey.
3. Master behaviours, not spreadsheets
This lesson took me many years to learn but it’s a goodie.
At the start of my journey, I was really attracted to the math and statistical side of FIRE. I loved reading about the Mad Fientist’s tax strategies (even though they were US based), MMM’s shockingly simple math behind early retirement and how the trinity study modelled over 80 years of data to come up with the 4% rule.
I used to seriously whip out the calculator on my phone at all hours of the night to crunch some number because I was obsessing over a 0.07% difference in management fees lol 😅.
But the further down the FIRE rabbit hole I traverse, the more I realise that spreadsheets, modelling and the math behind money management all meant diddly squat if your emotions and psychological makeup are not equipped to stay the course throughout your journey.
I’m not saying the numbers don’t matter, because they most definitely do. But our behaviours matter more.
“Financial success is not a hard science. It’s a soft skill, where how you behave is more important than what you know”
– Morgan Housel
There’s a great story that illustrates this point perfectly. In the intro of one of my favourite books, ‘The Psychology of Money’ by Morgan Housel. Morgan compares the stark contrast between an American Janitor called Ronald Read with a Harvard-educated Merrill Lynch executive named Richard Fuscone.
From his wiki page:
Ronald James Read (October 23, 1921 – June 2, 2014) was an American philanthropist, investor, janitor, and gas station attendant. Read grew up in Dummerston, Vermont, in an impoverished farming household. He walked or hitchhiked 6.4 km daily to his high school and was the first high school graduate in his family.
Read repaired cars at a gas station for 25 years and was a janitor at JCPenny for 17 years. He purchased a 2 bedroom house for $12K in 1959 and lived there for the rest of his life.
Friends of Read have been on record saying that he didn’t really get up to much. Some said his hobby was wood chopping and he lived a very low key life.
Read died in 2014 at the ripe old age of 92 which is where the plot thickens… Read made international news when he left over $6,000,000 (USD) to his local hospital and library. He also left over $2,000,000 to his stepkids too 🤯.
Read’s friends were dumbfounded. Where did he get all that money from?
Friends and family went looking for answers but they discovered there was no secret.
No lottery wins.
No hidden inheritance.
No hidden high paying secret spy job that he’d been keeping under wraps.
Read simply spent less than he earned and invested the rest in blue-chip stocks. The power of compound interest over decades did its thing and his low-income modest lifestyle managed to create a snowball worth more than $8M (USD) 🤯🤯🤯.
Richard Fuscone was in the news a few months before the passing of Ronald Read for very different reasons.
Fuscone is basically the polar opposite of Read.
To say he’s well educated is putting it lightly. Check this out for a resume
I mean damn! That’s some serious alumni. And for those who don’t know, the University of Chicago offers one of the most prestigious MBA programs in the world. We’re talking about the upper echelon of prestigious education here.
Fuscone was a high flying executive who retired in his 40’s to pursue philanthropy and was once included in a “40 under 40” list of successful businesspeople. Fuscone got into financial difficulty in the mid-2000s after he borrowed heavily to expand his 18,000-square foot home that had 11 bathrooms, two elevators, two pools, seven garages, and cost more than $90,000 a month to maintain.
Then the 2008 financial crisis hit.
High levels of debt coupled with illiquid assets left Fuscone bankrupt.
A few months before Ronald Read passed and left his fortune to charity, Richard Fuscone’s home was sold in a foreclosure auction for 75% less than an insurance company figured it was worth… ouch!
Ronald Read was patient, Richard Fuscone was greedy. That’s all it took to overcome the enormous education and experience gap between the two.
So what’s the moral of the story?
It’s not about how smart you are, it’s about how you behave.
4. Getting wealthy is simple. Don’t overthink it
“Life is really simple, but we insist on making it complicated.” – Confucius
Almost every single wealth-building strategy can be boiled down to three steps:
Spend less than you earn
Invest the surplus
That’s it… seriously.
Now there’s an absolute chasm between ‘get rich quick’ schemes and long term investing but those three principles hold true 99% of the time. How you invest and what you invest in doesn’t particularly matter. As long as you’re outpacing inflation and have strong conviction in your investments you should be moving towards financial independence.
Fidelity Investments is a multinational financial services corporation based in Boston, Massachusetts. An interesting discovery was made when a customer account audit revealed that the best investors in their database were either dead or inactive.
How could that possibly be?
How could someone that’s not adjusting their portfolio to the macro and micro economic news, outperform savvy investors with all the latest up to date data at their fingertips?
Well, it turns out that when it comes to investing… less is more.
Which is very unintuitive and goes against basic logic.
See the thing is, almost no one can beat the market over the long term. But people (myself included) constantly fall for the trap of trying to add complex financial instruments to somehow gain an advantage over ‘unsophisticated’ investors. I’ve always been raised that you need to put in the effort to reap a reward. You have to work hard to get anything in life worth having. This is true for most things… just not when it comes to investing.
I created and now invest through a trust fund because I associated its complexity and mystic with higher returns.
I thought I needed to do something different. I needed to outwork others to have a good return.
Choosing an ordinary index fund and adding to it each month without doing anything else just felt…lazy lol. I had all this pent up excitement after discovering FIRE and I wanted to channel this energy into the journey. I wanted to work my ass off so I could reach FI as quickly as possible and I felt like boring lazy index investing is only for people who aren’t willing to put in the work. It’s taken me years to accept that not only is this approach perfectly fine, but it’s also statically the most optimal choice most investors can make.
Keeping it simple also frees you up to concentrate on what’s really important in life which ties into the first lesson, to be happy.
Complexity has the potential to steal your most precious resources; time and energy.
Money is the slave that works for us, not the other way around.
5. What’s measured is managed
If I could give only one tip to anyone looking to be better with their money, it would be to start tracking your expenses.
You don’t even have to do anything else. I promise you that you’ll save money and optimise your expenses within the very first session. You might think that you know what you spend money on but I’ll bet the house that the first time you analyse three months of expenses, you’ll be surprised.
This lesson falls under the umbrella of Lesson 3 ‘Master behaviour, not spreadsheets’. It’s been well documented that keeping track of any metric and reviewing it regularly has a psychological effect on humans that can help us improve a focus area.
If a sprinter wants to be faster, they’ll keep a record of how fast they run.
If a presidential candidate wants to become the president, they’ll record and analyse poll data with their team.
If Tesla wants to design self-driving cars, they’ll create, test and record different algorithms continuously and keep track of what did and didn’t work.
I think you get the idea.
What’s measured is managed!
And if you’re not measuring the most fundamental aspect of FIRE, you won’t be able to manage it effectively. Plenty of people can still reach FI without ever tracking their expenses but I know first-hand that measuring how much you’re spending and what your spending it on has a lot of positive psychological effects.
Some of the positives of tracking are:
You regularly review where your precious dollars are being allocated to each month. Think back to lesson 1. ‘The ultimate goal is to be happy’. Is the stuff you’re buying ultimately making you happy?
You can accurately calculate your current FIRE number? Guessing how much you spend each year to maintain your current lifestyle can create stress and anxiety when the time comes to retire. You’ll second guess yourself. Even though things can and will change throughout your life, if you’ve been tracking your expenses for a few years you’ll have a much better idea of what size portfolio you’ll need to retire.
It’s super easy to trim the fat. Unused memberships and subscription services can sometimes fly under the radar. Reviewing expenses bring this wastage front and centre.
But be warned… overdoing this area can actually have negative consequences.
I used to be one of the worlds biggest tightasses (still pretty tight compared to most ‘normal’ people haha) but what I’ve found through the last decade of managing money is that the majority of people will find great success if they focus on the big four areas.
Food/drinks (including alcohol)
Try to optimise these big areas and don’t kill yourself for paying for a haircut.
I’d say that the top one (housing) is probably the most important. Buying a huge house at a young age can stunt your wealth creation potential. Spending 50+% of your paycheck on rent has the same effect. You want to get your snowball up and running asap and let the compound interest do the heavy lifting over many years/decades.
If you optimise those big four areas to a point where you’re living a great life whilst having a decent savings rate it’s only a matter of time before you hit FIRE 🎉.
Ultimately, this lesson is super effective at improving your behaviours when it comes to money management.
6. Income potential is often overlooked
Over the last decade, I’ve met and spoken to a lot of people who have reached financial independence and there seems to be a common theme.
They are good savers
They have a higher than average income
The funny thing is that a lot of these people are actually below average investors. I heard all sorts of stories about how they might have lost money on a development, got swindled by a pyramid scheme or lost it all on a speculative stock. Yet they seem to reach FI decades earlier than most after eventually figuring out some form of investment that works for them.
The bulk of their wealth comes from a healthy savings rate powered by a high income.
For the first 7 or so years on my journey towards FI, I focussed solely on saving a whole lot of money and investing it in both real estate and stocks.
It wasn’t until I moved overseas in 2019 and more than doubled my hourly rate did I truly appreciate the power of earning more money.
I mean it’s pretty obvious, isn’t it?
The more you earn the more you can save and reach FI quicker. But for some reason, I always prioritised saving more and reading the same investing strategies over and over again making little tweaks here and there.
Having a high savings rate is really important. I reckon we managed to optimise our expenses after 1 or two years at most. After that, it’s pretty much been on autopilot. We have a pretty good idea about what brings us joy and where our dollars go.
I’ve spent way too long (especially at the start) obsessing over the ‘investing’ part of the FIRE equation. There are soooooooo many articles, videos, books, podcasts etc. that dive into all sorts of whizz-bang investing strategies that it can be confusing as hell.
It’s sorta like when you go to the Cheesecake Factory. Their menu is so bloody big and confusing that it can be overwhelming. I’ll try to read absolutely everything because I don’t want to order a meal and then have food envy because something better was further down the menu 😂. This is what’s known as analysis paralysis and a lot of people can fall prey to it (it personally took me years of reading about the stock market before taking the plunge).
It’s natural to feel like you need to know absolutely everything before dropping your money into the markets. But the truth is that we all make mistakes and the most basic concept of investing is buying things (real estate, stocks, precious metals, bonds etc.) that make you money. Don’t stress too much about building the perfect portfolio because I’m telling you it doesn’t exist.
Index investing appeals to so many people because it’s passive, diversified, low cost and provides a great return with little effort. Don’t overthink it. Work out a portfolio that you have strong conviction in and one that will allow you to sleep at night. Save your money and keep adding to the portfolio regularly.
If you still have time and energy to commit to FIRE after your expenses are under control and you’re happy with your investing strategy, I’d seriously start to look to increase your income.
High savings+high income +below-average investments
is better than
High savings+below-average income+above-average investments
Obviously, it does depend on how epic your investment returns are but generally the above is true from what I’ve personally experienced and seen over the last decade.
There are heaps of ways you can increase your income. I wrote about a few of them in this article here.
7. Compound interest takes years to notice
I learnt about the power of compound interest pretty early. There’s that famous story about two colleagues that’s told 100 different ways but it always illustrates the same point. Investing early and taking advantage of compound interest pays off in the long run.
This little graphic is one example.
Image Source: Mark Catanzaro
I’d like to think most people in the FIRE community have come across this (or something similar) before.
But most people (myself included) have a hard time truly appreciating the magnitude of compound interest and it doesn’t start to feel real until you’re near the end of your journey. There’s something about exponential growth that makes it difficult to grasp from an emotional point of view even when we understand the math. I think it has to do with most other things in life being linear. We do basic arithmetic almost every day in our lives but I don’t know anyone who can compute exponential growth without a calculator.
If we need half a dozen eggs for a recipe and know we already have 2 at home, that’s a simple subtraction problem that’s easy to think about on the fly and makes sense. If we choose to buy a car worth $10K instead of $15K. That’s an obvious savings of $5K which makes it easy to immediately appreciate on the spot.
But it’s hard sometimes to come to grips with putting away large sums of money now so the future you in 10-30 years can live a better life.
Here’s one of my favourite examples of exponential growth that you can play with your friends.
The story of the monthly coins.
If I gave you $1 each day in the month of January, how much money would you have at the end of the month?
Most people would be quick to shout $31 right.
But suppose I gave you $1 on the first day of January and double it every day until the end of the month ($2 on the second day, $4 on the third and so on), without cheating, try to have a guess in your head how much money you would have at the end of the month.
Take a few seconds to think about it and keep a mental note.
The answer is $2.1 billion dollars. That’s a billion… with a B 😱
Try this example with your friends to see what number they guess. 99% of the time they won’t get anywhere near the correct answer.
I use the example to illustrate the point that compound interest is not intuitive to grasp and it really only starts to take off in the later years. Speaking from experience, I really noticed compound interest once we had around $400K+ invested and our FIRE number is $1.25M for context.
Before that, it feels like you’re doing all the heavy lifting yourself through savings (which is pretty much what’s happening).
But boy oh boy it’s an amazing feeling when the freight train starts to pick up steam and suddenly your investments are making more money than you can save each month. After that, there’s no stopping it and you’ll feel like you’re almost cheating as you race towards the finish line.
8. Most people are really after semi-retirement
Every single financially independent person I’ve ever met, read about or listened to still ‘works’ and makes money outside their investments one way or another.
I’ve added talking marks to the letter ‘work’ because it’s not really traditional work but people can get really anal when it comes to the word retire. I’ve always interpreted RE (retire early) part of FIRE as the moment you quit your cubicle/wage slave job and pursue meaningful work that brings you purpose.
But this can be confusing because not everyone has something they’re super passionate about. There’s a large portion of the community that really likes the social aspect and comradery of their normal day job but just want a little bit more free time in the week to get stuff done and enjoy life.
Based on the emails I’ve been receiving for the last 7 or so years I’ve come to the following conclusion. Most people in the FIRE community are really just looking to work 2-3 days a week and maintain their current lifestyle with some passive income to cover the rest/set them up for retirement in their golden years.
And as someone who is currently only working 3 days a week, I must say that I’m becoming more convinced that semi-retirement is the sweet spot for the bulk of the community too.
Full financial independence is great and it’s what we should be aiming for later on in life, but building up a portfolio that kicks off enough passive income to free up one or two days a week can have astonishing results.
And the best part about compound interest is that the momentum you build up early on in the journey only gets stronger and can carry you all the way to full fledge FI without you needing to add to your portfolio after a certain point.
This concept is known as Coast FI or Flamingo FI and the end result is the same. Full financial independence.
But if you drop down to semi-retirement during your journey you’ll obviously not have as much money to contribute to your portfolio and won’t reach FI as fast.
The odds of someone never working and making any sort of income outside of their portfolio ever again after reaching FIRE is incredibly low. I’ve been saying this for a few years now but the 4% rule is over-conservative in my book. Putting aside the fact that the author of the 4% rule has increased it to 5%, any additional income after you’ve reached FI completely blows out the modelling.
Let me give an example.
Our FIRE number is $1.25M which will generate $50K per year based on the 4% rule.
Let’s assume that we get to the $1.25M, declare FIRE but decide to both work 1 day a week for 8 hours at $30 an hour.
Would you believe that our combined take-home income would be ~$25K a year? That’s half of what we need to bloody live on!
The portfolio could easily cover the rest and here’s the amazing part. Because we wouldn’t need to be drawing down 4% of the portfolio, it could compound away for longer at the higher amount.
Here’s what half of the portfolio ($625K), if left alone, could potentially grow to given an 8% return after 10 years.
~$1.35M is more than our original FIRE number!
And it’s really important to realise that we only worked one 8 hour day at $30 an hour in this example. You could imagine how dramatic the modelling changes if you worked an extra day or charged a higher hourly rate.
There are two main points here.
You’re almost certainly going to be earning money post FIRE
The 4% assume no extra income ever. This is extremely unlikely if you reach FIRE in your 20’s, 30’s, 40’s or even maybe 50’s.
9. Find your ‘enough’
Joseph Heller, an important and funny writer now dead, and I were at a party given by a billionaire on Shelter Island. I said, “Joe, how does it make you feel to know that our host only yesterday may have made more money than your novel ‘Catch-22’ has earned in its entire history?” And Joe said, “I’ve got something he can never have.” And I said, “What on earth could that be, Joe?” And Joe said, “The knowledge that I’ve got enough.”
— A poem for The New Yorker in May of 2005 by Kurt Vonnegut
I honestly think there’s something in our DNA as humans to always want more.
It has to be some sort of evolutionary trait right.
Imagine two homo sapiens coming across an enormous fruit tree bearing 50 ripe Apples.
The first human decides to only eat enough to be full and then leaves.
The second human gorges themselves and then picks and carries as many as they can hold back to camp with no consideration of others.
Which personality traits do you think has the better chance of surviving and passing on their genes to the next generation? As unfortunate as it is, selfishness is rewarded in the animal kingdom. I know it’s hard to imagine with all our fancy pants technology and civilisation, but we’re not actually that far removed from our prehistoric ancestors and evolution hasn’t yet caught up to deal with the current situation we find ourselves in.
Most of us are hard-wired to always want more.
But you’ll never become FI if your desires and wants continue to increase forever.
Think back to lesson one “The goal is to be happy”.
If you desire something and you don’t have it, this usually results in a feeling of unhappiness. And there are only two ways to fix it.
You work hard and get what you want.
You find happiness elsewhere and stop wanting it.
Depending on how exorbitant your wants and desires are, option 1 could mean many decades climbing the corporate ladder working 70+ hours weeks to fund your:
3,000sq m Toorak mansion
6 beds, 5 bathroom holiday house in Byron Bay
3 jet ski’s
And so on
Now I don’t want to be judgemental here. If you really want all those things and think the work required is worth it. Sweet. Go for it. Everyone is different.
But if you’re reading this article, odds are that you’re more attracted to the idea of living a simple yet great life that prioritises freedom, autonomy, health, relationships and ultimately happiness.
Figuring out what your ‘enough’ is takes a long time. This is partly because our wants and desires evolve as we get older and our circumstances change.
I for example, never really put too much value in travelling before 2019. I’d been on a few trips here and there and whilst it was good fun, I used to think that international travel was insanely expensive and overrated. Travelling around the world and living in the UK for 2 years completely changed my outlook on a lot of things and broadened my horizons. I now consider travelling to be part of our lifestyle and something we will need to factor into our numbers.
And even though I think a little bit of lifestyle inflation is perfectly normal and healthy, you’ll never have peace of mind until you discover your ‘enough’.
If you don’t figure it out, you’ll always be wanting more.
10. We’re all dealt a different hand in the game of life
There’s a quote that I can’t seem to find that loosely goes like this.
A CEO was perfectly happy with their $1M bonus until they found out a competitor CEO received $100 more
Comparisons. We’re all guilty of making them.
And the messed up part is sometimes we were happy until we see what someone else has.
It happens all the time and is part of the reason I’ve disconnected all of my social media accounts.
Practising the art of gratitude can be really helpful to remind yourself of all the great things in your life. But we’re humans and I’ve fallen victim to unrealistic comparisons a bunch of times. It’s perfectly natural to stumble across someone who you may have gone to school with and be jealous of the life they’re living now.
What I’ve come to realise after hearing from literally thousands of Aussies on their way to FI is that there can be a gigantic gap between peers within the same cohort. I’m talking about the advantages and disadvantages between two people who on surface value seem to be pretty equal.
There’s a great book called Outliers by Malcolm Gladwell that explains just how incredible one little advantage early on in someone’s life can completely change their trajectory.
Did you know that 40% of the best hockey players in Canada are born between January and March?
This is no coincidence. It turns out that in minor league hockey, children are grouped by birth year and players born in January are, on average, bigger and taller than December-born players.
This seemingly unimportant attribute gives players born in the first months of the year a head start that turns into a lifelong advantage.
That one little leg up can have the following flow-on effects:
They are bigger and stronger than their peers which makes hockey easy for them
They are noticed by coaches and identified as a good player. Extra coaching or special treatment may be given
They will most likely be chosen to represent their squad team which means more playing time against a higher level of competition and access to better coaching
They continue to get extra playing time against elite competition with the best coaches in the country year after year
These sorts of advantages happen all the time and compound throughout one’s life.
The same is equally true for disadvantages.
But it’s really hard to know what cards a person has been dealt even if you know them quite well. And it’s almost impossible when reading a stranger’s blog or listening to a guest on a podcast.
The goal of FI is a mastery of money that’s a personal journey.
A little bit of healthy competition can be good but never feel inadequate when you come across someone similar who seems to have it all figured out. They may have been dealt two aces.
The reverse is also true.
We have no idea what has happened in someone’s life that has influenced the position they’re in now.
In summary, compete against the person in the mirror.
Wake up each day trying to be a better version of yourself.
“Comparison Is the Thief of Joy”
— Theodore Roosevelt
That’s a wrap! 10 the biggest lessons I’ve learned over the past 10 years pursuing FI!
I’d love to know what was your favourite lessons in the comment section below 🙂
The below article is actually a chapter I wrote for a great collaboration ebook put together by Pearler. I would highly recommend checking out the entire eBook (for free of course) which you can grab here.
“A dollar saved is better than a dollar earned”
We’ve all heard that one before. The ability to save more than you earn is a fundamental principle upon which FIRE is built.
Hands-down the most important step for reaching FIRE is how much of your paycheck you can keep and invest.
You cannot earn/invest your way out of bad money habits. It will eventually catch up with you no matter how much money you make. If you’re spending more than you earn, you’re going to be broke. It’s just simple mathematics!
It’s sorta the equivalent of trying to outwork a bad diet and expect results in the gym. In fact, there are so many parallels between good financial habits and being fit and healthy it’s uncanny. Most health/fitness experts would agree that your diet probably plays the biggest role in keeping your body happy. The other two major players would most likely be exercise and sleep. If you’re nailing all three of those, there’s a pretty good chance your body is feeling awesome.
Savings is to FIRE, what eating the right foods is to living a healthy lifestyle.
And if we follow this little analogy a bit further we might conclude that…earning money in FIRE is equivalent to or around the same level of importance as exercise when it comes to health and fitness. And maybe we can put getting a good nights rest at the level of investing.
It’s not a perfect one for one comparison but it makes for a good metaphor so let’s keep rolling with it.
I’d wager that 90% of FIRE content is either about saving money or investing. But we seldom read how to earn more money even though it has astronomical benefits when implemented correctly. It’s true that FIRE is income agnostic, two people with a savings rate of 65% will both reach FIRE in around 10 years even if one earns $60K and the other $400K.
But there comes a point of diminishing returns for both saving money and investing.
The purpose of this article is to explain how beneficial it is to spend more time and energy increasing the amount of $$$ that flow into your accounts. Anyone who is on this path is already doing some form of exercise (earning money) but if you can look past your standard crunches and pushups you’ll discover there are gymnasiums out there filled with weird and wonderful machines that provide all types of workouts. And when you combine a great diet with a dialled in training routine that works best for you, the gainz can be off the charts.
The aim here is to illustrate just how much of an impact increasing your income (even a tiny bit!) can have on your journey towards FIRE.
Let’s try and apply the same metric to the three most important focus areas IMHO when it comes to reaching FIRE.
Save more than you earn
Increase how much you earn
Invest your savings
We’ll call the metric BFYB (bang for your buck). BFYB= The amount of effort required to improve a focus area
Let’s look at our first focus area (save more than you earn) and re-establish why it has the best BFYB value. Increasing Your Savings Rate
We’re assuming he is a single 30-year-old Sparky from Brisbane who owns his 3 bedroom home (no mortgage), works 38-40 hours a week, doesn’t have kids and all the below numbers stay constant over the next 30 years to make the modelling super simple.
Ok, so an Australian who earns $80K with a savings rate of 30% can retire in 21.2 years. Not too shabby.
A 30% savings rate is already way above the average but let’s just assume Joe, whilst obviously a diligent saver already, is living a pretty normal consumerist 21st-century lifestyle with a heap more fat to cut. I don’t think it’s unrealistic or even that hard for him to go from a 30% savings rate to 40% given his circumstances above. The difference between 30%-40% is $5,538 a year or $106 week. I would almost guarantee that 90% of Australians spend more than $106 dollars a week on things they don’t need or even want half the time (myself included). Optimising big-ticket items like housing, transport and food would almost certainly save a whole lot more than the $106 a week we require for this example.
Anyway, if we bump the savings rate up to 40% we wipe off 4.5 years!
Everyone’s circumstances will vary but the effort required in my guesstimation for Joe to increase his savings rate 30% to 40% is rather small and the BFYB is high.
This is what we want. Low effort, high reward.
And it’s why focusing on your savings rate is absolutely the best way to decrease the amount of time towards FIRE… up to a certain point.
There comes a point of diminishing returns where focusing on your savings rate will not yield a good BFYB and the hard part is that it’s different for everyone because of circumstances. I can only speak for ourselves but this is what our savings rate BFYB chart looks like:
Currently, we can pretty much save close to 40% of our after-tax income without breaking a sweat. That means no sacrifice or comprising on anything. The effort for us to save 40% is almost the exact same as saving 10%. But the effort required to maintain a savings rate of >60% is when things start to change. For us to optimise our lifestyle further and squeeze out a few more percentages is astronomically harder to do when we start to get around the 65%-75%+ range. Don’t get me wrong, we could do it. And that would speed up our journey to FIRE… but at what cost?
If I can draw from our earlier metaphor of our savings rate being similar to a diet, we could say that cutting out junk food during Monday-Friday and making sure you eat some sort of leafy greens every day is a realistic goal with huge health benefits. But if we tried to never drink alcohol or eat Macca’s ever again, firstly we might be setting ourselves up for failure and secondly, whilst being the healthy option, it’s not going to have as big of a health benefit as the first goal. There are diminishing returns for eating healthy just like there are diminishing returns for improving your savings rate.
Increasing Your Income
This is the focus area that doesn’t get enough attention.
Increasing your income has a direct correlation with your savings rate but for whatever reason, a lot of people never put in the time and effort to improve it. There’s so much low hanging fruit which doesn’t really require a whole lot of effort but has a high BFYB value.
Let’s look back at Joe Smith from above but change one thing. Instead of him saving $5,538 a year, let’s have him earn an extra $5,538 (after tax) a year and see what happens.
Joe increased his after-tax income by $5,538 which in turn wiped off 2.7 years! BFYB:Really good
We’re going to be talking about the low hanging fruit later on but if I’m being honest, Joe could easily make an extra $5,538 (after tax) purely from giving up more of his time. If we assume he’s making an after-tax hourly rate of $28, he would only need to put in an extra 197 hours worth of work over the year. And that’s not even factoring in overtime or weekend rates. An extra hour for 197 working days a year is really not that much.
Some of the stories I’ve heard first hand from young London bankers is absolutely mind-boggling. Think 70-80 hours per week… and work on weekends is to be expected!
2.7 years is not as good as our savings example above which wiped out 4.5. But if we combined them, we get epic results!
Improving our savings rate and increasing our income by the very same amount has annihilated 6.53 years of working.
Now we’re cooking with gas!
But just like our savings rate, there are diminishing returns in the pursuit of increasing your income. And I keep coming back to circumstances but unfortunately, it’s very much a circumstantial question when we start talking about this focus area because we all aren’t on an even playing field.
Below is my personal increasing income BFYB chart:
Let me explain what this means because it’s important.
Let’s say I’m unemployed next year (which is what’s most likely going to happen when we move back to Australia) and my salary is $0 (ignoring any investment income of course). I’m scanning through the classifieds looking for my next job, which, for this example will be the sole source of my income.
For my circumstances personally, it doesn’t require any extra effort for me to land a job paying $100K as opposed to around $35K annually. I don’t want to sound overconfident but I have a certain set of skills and experience that the market is willing to pay me and I’m 99% sure I could land a job paying close to $100K no worries. In fact, I’d probably have a harder time getting my old job back at Coles if anything. Beyond $100K is when the effort required starts to increase and the BFYB value starts to go down.
Remember, BFYB = The amount of effort required to improve a focus area.
The effort required to earn a salary past $100K starts to increase a lot and for me personally, the extra effort doesn’t justify the extra income at around the $130K-$150K mark. Beyond that, there’s too much sacrifice with not enough gain. Too many responsibilities and work-related stress that I don’t feel is justified for the extra $$$. You may have certain skills and experience where earning $150K is actually quite easy and no different (in terms of effort) than earning $100K.
If we look at the ABS data from 2018 the median income for a full-time employee in Australia is $76K a year. If we adjust for two years of inflation we can round it off to 80K and we now have a benchmark.
$80K a year is the standard form of exercise for full-time Aussies. One light jog and occasional push-ups weekly would probably put you in the average to above-average category of exercise in Australia as sad as that is.
If you’re earning under $80K a year and have already optimised your expenses, you may be in the position to grab some really low hanging fruit and increase your income for an excellent BFYB return.
Adding in some resistance training 2 hours a week is such a small amount of effort that has an incredible return. Not only will you become healthier and stronger, you’ll potentially save yourself a lifetime of injury and illness that’s so common in our sit down all day 21st-century culture. Cardiovascular and resistance training has shown to help with sciatica, pelvic tilt, back pain, heart disease, diabetes etc. I have always considered myself a pretty active person but even I had hip issues 3 years after starting full-time work which I 100% attribute to sitting down all day and not stretching my hip flexors or strengthening my glutes. This hip issues crept into a lower back pain issue and before I knew it, I was going to the physio a few times a month. It didn’t take longer than a few weeks of specific stretching and strengthening exercise to completely resolve all of my issues and I continue parts of that program to this day nearly 10 years later.
You don’t need to jump into a 5X5 strength split or start yelling “Yeah buddy…Ain’t nuttin’ but a peanut!” after every rep in the gym. Three focused 45-minute sessions a week offers great health benefits just like spending a bit more time increasing your income can wipe years off your FIRE journey!
Improving Your Investment Returns
And now we’ve come to the most talked about, most analysed… most overrated focus area.
I want to bring up two quotes to set the tone for this focus area.
“If investing is entertaining, if you’re having fun, you’re probably not making any money. Good investing is boring.”– George Soros “There seems to be some perverse human characteristic that likes to make easy things difficult.”– Warren Buffett
I am so guilty of the second quote. When I first discovered financial independence I was convinced that there’s some sort of magic formula that these rich guys must be using to get ahead. It’s part of the reason I started investing in a trust. It was like this complicated black box with all these advantages that only the rich guys understood and used. I wanted in on the secret and did my research hoping to stumble upon the golden goose. While there are some benefits of investing within a trust, I must admit that I was lured to its complexities and perceived mysteries (for whatever reason). It took me years to fully appreciate the power of simplicity and if I could start again, I would have never bothered with the trust.
I feel so many FIRE n00bs fall into the same trap. They go looking for a magical formula that simply does not exist. And even if it does, it’s almost certainly locked away in a secure blockchain quant investment hedge fund somewhere.
Here’s the deal, you can absolutely optimise your investment results up until a certain degree with barely any more effort involved. I’m going to ignore inflation, risk appetite and investment horizons for a second to make the point.
Investment returns have historically fallen around these marks:
0% – Storing your money in a shoebox under your bed
2% – HISA
3.5% – Bonds
7% – Real estate
8% – Shares
You can argue back and forth about how those numbers were gathered and what methodologies were used but it doesn’t really matter.
Realistically, any Aussie out there can achieve those returns rates in those asset classes without an economics degree. Index investing opened Pandora’s box and enabled the average Joe to grab a piece of the market without needing to spend the time researching and analysing financial statements.
Diversification and low management fees provide the best BFYB when it comes to this focus area. Everything else has such minute benefits that it’s laughable so many people spend so much time and effort trying to see which ones better.
To demonstrate this here is our BFYB chart for investment returns
So basically we can get up to around 8% without much effort required. It’s always good to put the time and effort into understanding the asset class but theoretically, any Joe Blow could dump their money into a diversified index fund like VDHG and get ~8% over the long term.
I don’t know any assets class where you can get a better return without extra effort. There’s plenty of ways to improve your return on investment. I sold my first investment property and calculated an after-tax annualised return of 36% but the number of extra hours I put into that investment was the equivalent to another part-time job.
Newbies to FIRE and investing don’t really understand just how hard it truly is to beat the market consistently over a long period of time (20+ years). There are people who can do it, I’m not saying it isn’t possible. But the amount of effort and skill that is required to actually discover alpha year after year is something only a very few incredibly skilled people have managed to achieve.
We’ve all heard the famous story of Warren Buffett betting a $1M bucks against 5 hedge funds that a simple index-tracking ETF would outperform them over an eight-year period. Not only did he win that bet, but it wasn’t even close.
But let’s just entertain the idea that you’re an outlier. You possess incredible skills and techniques far beyond most active traders and hedge fund managers all around the world and you’re able to consistently beat the market.
How much better off would you be if you were able to outpace the market by a whopping 100 basis point (1%). 1% doesn’t sound impressive but if someone can beat the market by 1% over a long period of time then you’re most likely going to make more money in a hedge fund picking stock than you are at your day job. Your skills are extremely valuable.
We’re going to pretend that you keep this incredible skill to yourself and only use your god-given talents for your personal share portfolio. How much of a difference would 1% actually make?
Let’s find out.
Even using our top tier investing prowess we only managed to wipe off 2.3 years which was actually the worst result compared to saving $5,538 (4.5 years) or earning an additional $5,538 (2.7 years). BFYB:Bad
Think about how much time and effort some funds put into research for investing. It’s a full-time job with an army of analysts and advisors all crunching numbers, creating models and using the latest predictive methods in the odd chance that they can justify their hefty management fees. And most of these funds don’t even beat the index when fees are accounted for.
What hope in hell do the rest of us have?
The example above used a huge 1% difference over nearly 20 years.
How many times have you seen someone ask about A200 vs VAS on the internet? It’s gotta be one of the most discussed and analysed topics within FIRE communities. The difference in management fees between these two funds is 0.03%…
Let me say that again. 0.03%
They do track different indexes (ASX200 vs ASX300) and do you know what the difference has been between those two indexes over the last 10 years… 0.04%
So maybe… just maybe those two funds might return a difference of +-0.1% over the long term.
10 basis points of difference is your reward for correctly picking the better performing ETF over that time period.. and that’s assuming you’re even able to use skill to pick the one that’s going to perform better (which you almost certainly won’t be able to do). BFYB:Horrendous
A200 or VAS?
A200+VGS or VAS+VTS+VEU?
IVV or VTS?
AFI or VAS?
LICs or ETFs?
VDHG or create my own?
Most of these arguments don’t make a huge difference. It’s really important to understand the key concepts around management fees, diversification and why index investing works. But just understand that if you’ve got one of the above combo’s, you’re already more diversified and paying lower fees than most Australian investors to begin with.
The basic investing principles for Australian FIRE is to build a low cost, diversified share portfolio mainly made up by ETFs/LICS. You want to buy consistently no matter what the market is doing and grow your snowball to a point where it’s passive income can fund your lifestyle.
There’s going to be a 100 different flavours of that ice cream but once you have those basics down pat, the bulk of the work is done. You can always tweak and improve your portfolio to suit your circumstances but honestly, if you’re trying to reach FIRE faster and think that crunching numbers in Excel for 10 hours a week is going save you years of working, you might be in for a rude shock!
Keep your investing simple and boring. Use your precious time optimising your expenses and working on ways to increase the amount of money that flows into your account because IMHO, focusing time and energy on savings and increasing your income has the best BFYB returns.
Different Ways to Increase your Income
I hope after reading the above you can now appreciate just how underrated increasing your income is. The saving rate is held in high regard within the FIRE community thankfully, so there’s not much to add there.
But my goodness does investing get way too much of the limelight. It’s largely out of your control too. Other than choosing your diversification levels and sticking to a low-cost fund, you’re very limited to how much you can improve the results.
When it comes to increasing your income though, the complete opposite is true. The harder you grind the more money you will make! And the more money you make, the higher your savings rate will be (if lifestyle inflation doesn’t get ya)
So let’s jump in to see how we can improve our crunches and pushups and maybe head over to the dark corner of the gym, away from the treadmills and cross-fitters… the weight room!
Ask For A Raise
We’re going to start by improving our current workout (salary job).
One of the easiest and most low hanging fruits on anyone’s list should be to simply have a conversation with their boss about their salary and ask for a raise if they think they deserve more money.
How many times have you heard about someone complaining for years that they’re underpaid but never actually taking the action of setting up the meeting to discuss their pay? I’m not saying this will have a 100% success rate but more often than not, it will start the process of you either getting more benefits or creating the plan for your next raise or bonus.
You probably want to approach the meeting with some sort of reasoning like citing average incomes within your industry or comparing the work you do with someone else that’s being paid more. BFYB:Great
Hardly any effort with the potential to add thousands extra to your accounts for years to come! No real risk either and it’s not like you have to learn something new.
Change Jobs Regularly
Asking for a raise or putting your head down and bum up climbing the corporate ladder is a noble way to jump the food chain and reap the rewards. But the sad truth in my experience is that loyalty to a company (or business for that matter) is rarely rewarded.
Your utility provider doesn’t offer a better deal when you’ve been a loyal customer for 10 years. It’s only when you leave do they all of a sudden roll the red carpet out.
If your goal is to make the most money in your field, changing jobs every 2-3 years is the best way to do it.
Be bold, be confident. Apply for positions beyond your capabilities. Back yourself to get the job done after you land it.
Fortune favours the bold!
I’m not saying to lie your way to a position only to fall flat on your face. Just understand that an ungodly amount of people are in jobs they were never qualified for or completely lacked the experience necessary to perform it at the start.
When I worked for the government back in Australia, we would engage with consultants all the time from various companies who always charged an obscene day rate to perform projects. Think $1,000+ a day. I worked directly with a lot of these consultants on the technical side and it always struck me as odd when they clearly didn’t know a whole lot. Here we were, getting charged $1,000 a day and I would end up doing 30% of the work.
Fast forward 5 years and I became a consultant myself after picking up contract work in London. My second contract was at one of the big four global consulting firms who are widely regarded as having some of the best professional services networks in the world. And boy do they charge accordingly for that reputation.
I worked on client-side with a team of consultants but was the only contractor. Two of the team members were really junior. One was 18 months out of uni and whilst really smart and willing to learn, didn’t know a whole lot about the technologies we were implementing.
My day rate for that contract was a whopping £500. It was more than double my daily earnings from back home and I couldn’t believe that a company would be willing to pay me so much.
Well, you might have guessed that I was completely blown away when I found out that the consulting company who I was subcontracting for, was actually charging me out at their SC (senior consultant) rate which is a staggering £1,250 a day 🤯. Even at £500 a day, I was only getting 40% of the pie!
And now it made sense why all the firm’s partners were driving McLaren’s…
But here’s the point of the story… everyone on the team was also being charged out at £1,250 a day!
I mean… honestly. One of them barely knew anything. And it was at this point that I realised that companies will lie and exaggerate the skills and experience of their products/services in order to get the most amount of money they think they can get away with.
You should be doing the same!
Last point on this one, be prepared to move somewhere where your skills are in demand. This might mean international. BFYB:Great
Time to get out of your comfort zone!
The two tips above were focussed on improving your current situation. Everyone’s working out to some degree so it would make sense that we start by improving your running technique or buying training gear. But now I want to take you into that dark corner of the gym where you might not have been before. It’s not going to be easy and learning new things can be difficult. But I promise you that the benefits here are worth the effort.
I’d rather not bore you by listing every single side hustle I can think of either. I have personal experience in a few side hustles which I’d like to talk about but there’s really an unlimited amount of ways to bring in a little extra cashola.
Work a second job:
This one depends on how exhausted you are working your main job, but there’s plenty of people who work two jobs and cope just fine. Mrs FB used to do a bit of bar work on Thursday and Friday nights even though she didn’t need to. She worked with her sister and a few friends and half the time most of her friends were drinking at the bar (a small country town so not many other options lol) so she was sort of where she’d be anyway just earning money instead of spending it. A little bit of extra work equated to thousands of extra dollars in her account without too much effort involved.
The second gig can be anything too. Teaching piano, tutoring, Uber driver etc. BFYB:Ok
One of my biggest pet peeves is throwaway culture. The amount of effort that went into digging something out of the ground, refining it, transporting it, manufacturing it, shipping it, storing it and to have someone finally buy/consume it… only for it to be thrown away in the trash not long after.
Never throw away something just because you don’t want it anymore. If it was once a good product, odds are you can sell it online to someone and recoup some of your losses. Hell, I even managed to sell my old pair of Nike’s for $30 once. Legit took me less than 10 minutes to list it. How many of you out there would be willing to work for $180 an hour?
At worst go down to your local Salvos and donate it. Chucking something that is perfectly fine in the trash is sooooo lazy, a bad financial habit and adds to humanities ballooning trash pile that mostly ends up in our oceans. BFYB:Ok
Credit Card Hacking:
I’ve been credit card hacking for nearly a decade. In a nutshell, you sign up to new cards to take advantage of the signup bonus these CC companies offer and then spend the points on products, flights or convert them to cash. You can also pay for everything on the CC and accumulate points over the course of the year. A little bit of effort for a pretty decent bump IMO. The only risk is that you need to ensure you pay off the CC amount in full at the end of each month.
Oh, and some cards come with free travel insurance which can cost hundreds of dollars. BFYB:Ok
Something I only discovered in 2019 after ignoring it for nearly 6 months because I thought it was a scam. The principles are very similar to CC hacking. The bookies offer you signup bonuses where you join with the caveat that you need to gamble the bet in order to access it. Matched betting is the mathematical approach for discovering arbitrage opportunities between back and lay bets. Or simply put, playing the bookies against each other to make money. When you do it correctly it’s mathematically impossible to lose but it’s a lot more complicated than CC hacking.
There’s a lot of low hanging fruit here for those who who want to put the time and effort into learning it. The two advantages that matched betting has over CC hacking is that firstly the amount of money you can make is a lot more. The low hanging fruit can be anywhere between $1K-$2K. And secondly, matched betting can be done for an extended period of time and not be just a one-off. I’ve had many people email me about the money they have made from matched betting exceeding $15K.
The signup bonuses are the low hanging fruit because after that it basically turns into another job. The fact that you can do it over the internet is a huge plus in my book.
I’ve become an enormous advocate for having a crack at online business.
There are just so many advantages that being 100% online offers to the traditional way of doing things.
Some of my favourites are:
Can run the business/company from anywhere in the world as long as you have an internet connection
Startup speed. You can literally create a website/blog/YouTube Channel and begin creating content/a product and have the world at your fingertips within hours. This is simply mindboggling and it gives any entrepreneur a realistic chance to create something that will be successful.
Incredibly small start-up costs. Gone are the days where you’d have to risk financial ruin in order to start a business. How many people over the last 100 years have had a killer idea but lacked the capital to get it off the ground? I think Aussie Firebug cost me <$100 the first year.
Can scale as your business grows. This is what I love about cloud services in general. You only pay for how big you are and you can scale in a matter of seconds to accommodate a larger audience if/when you get there.
Aussie Firebug will always be a passion project but around late 2018 I officially started to monetise my content and miraculously it managed to make over $30K last year and I’m on track to make it again this FY.
I could do an entire article about how to monetise a blog/podcast because making money digitally is such a new concept (relatively) and there’s a lot to get your head around. Even though I’ve already listed a whole bunch of benefits above, probably the biggest advantage that an online business can offer someone on the road to FIRE is its ability to make semi-passive income.
A website/podcast/YouTube Channel is constantly available to everyone in the world. It’s not like a shop where you need to physically be there to make things run. And if your product is digital (you’re not selling something physical) you don’t need to store it and it can be replicated without any cost. If you sell a physical book you will need to pay to get that book printed and shipped. If you sell an ebook, you can literally just copy and paste a new version and send it to people straight away. The power of the internet!
Plus there’s a whole bunch of automation you can set up in the background where a lot of the day to day business operations can run on autopilot.
I think back to how many hours I put into Aussie Firebug during the first three years. The amount of time was crazy, probably averaged 1.5 hours each weeknight for 3 straight years. But the beauty of something like a blog/podcast is that most people are making the content because they really enjoy it. I didn’t earn anything for the first three years but I built the content that would later be the main drivers to allow the site to be monetised.
I’ve made over $60K during the last 2 years and I’d say on average I’m lucky to spend ~5 hours a month these days. My life has become completely different since moving overseas and travelling around and I just can’t dedicate as much to Aussie Firebug as I would like to.
But the point is that I’ve set up certain automations that enable the site to make me money while I sleep. I can’t tell you how satisfying it feels to wake up most mornings and see people taking advantage of companies that I use and recommend.
This concept is immensely powerful no matter what the online business is. Work can be recycled and can continue to make you money even while you sleep. I know a YouTuber that basically earns most of his money from a few videos he recorded years ago. Yes, he still continues to make new videos to keep the channel up to date, but the bulk of his income is still being generated from 2 or 3 pieces of digital content he created a long time ago.
That’s something you simply cannot do when you trade your time for money.
If you’re thinking about creating content I’d probably say that YouTube is the easiest way to start earning serious cash, followed by starting a podcast and unfortunately, dead last would be blogging.
The Double Whammy Effect
Side hustles and online businesses are a great way to bump up your income but there’s also a massive opportunity to simultaneously work on something that’s often forgotten about.
What are you going to do once you reach financial independence?
You don’t need to be FI to start plugging away at your passion project or whatever it is you’ve always wanted to have a crack at.
Start that project this weekend!
Momentum is a powerful force. If you have a little side hustle or project you get to work on for fun in your spare time, more often than not, when you do decide you’ve had enough of sitting in a cubicle for 40 hours a week, the transition is so much easier because you’ve already built up something to further sink your teeth into.
My preference will always be an online business but it doesn’t have to be that. Make candles, sell scented oils from Etsy, create a monthly COD tournament in your area. Anything you’re interested in will do. And don’t worry about making money because 9/10 times if you start doing something you love it somehow finds a way to pay for itself eventually.
Wrapping It All Up
I wrote this article with the intention of highlighting one of the most underrated focus areas in our community. Everyone should know by now that your savings rate is king but rarely do I see such admiration for putting time and effort into earning more money in your day job or by hustling on the side.
Far too often people come to the FIRE community hoping to discover the secret sauce that enables us to retire 30 years earlier than most. The methods we use to invest are actually incredibly boring and simple.
If you’re anything like me, discovering the concept of FIRE can change your life. I was bursting with excitement and enthusiasm when I realised that financial independence was an achievable goal that nearly any Australian can achieve if they prioritise it highly enough.
Focus more of this energy into something that’s within your control. That’s saving money and earning more. The majority of investment returns are largely out of our control which is why the never-ending debate between which investment is the best is largely a waste of your time. I’m not saying you shouldn’t educate yourself about investing. Just know that the difference between choosing A200 or VAS will not be a difference-maker that could potentially wipe years off your journey.
On the contrary, starting a hobby of making and selling custom jewellery in your spare time does have the potential to eliminate multiple years and maybe even decades. But more importantly, side hustles/businesses can offer the more important benefit of shaping your future in retirement. No one wants to reach financial independence just to say they did it. We want the freedom that it grants. But using that freedom to create your ideal lifestyle doesn’t have to start once you reach that magical number, you can start meaningful work right now and it can help you along the journey!
If I can refer back to our metaphor from the intro one last time I’ll leave you with this…
Most of you guys already have a great diet. Some are dialled in so well that you are hitting your macro and micro-nutrients to the gram. But it’s time now to look at your workout routine and see if you can fit in a few more sessions every week to really take it to the next level!
Firstly, you must reach financial independence (FI) where you’ll need to have enough assets generating enough money to cover your expenses forever.
This is pretty straight forward and whilst there are different variations of what people consider financial independence it’s much less convoluted then early retirement (ER).
Which is the second part to the FIRE equation and by far the most important.
I’ve done my fair share interviews for media outlets reaching out to me because they wanted to know more about the FIRE movement and what it’s all about. For some reason, I had quite a few in the last few weeks which you can listen to here, here and here.
These interviews prompted me to make this post because the question that ALWAYS comes up is why would a bloke who has 50+ (hopefully) years left in the tank want to retire?
Wouldn’t it be boring?
So I’m here to set the record straight as to what I consider ER is and why it’s the more important step!
What Is Early Retirement?
The most misunderstood and important part about FIRE has to be ER.
It’s mostly because the word ‘retire’ has a certain connotation with most people. If you actually look up the definition of retirement you will get different answers depending on which dictionary you are reading.
Retire Early in a FIRE context does not mean you stop working!
I honestly could think of nothing worse than to sit around all day doing nothing for 50+ years and I’ve yet to hear about anyone who achieves FIRE handing in their resignation letter only to sip Pina Coladas by the pool and play golf all day until they die.
Meaningful work that ignites a passion is awesome. I want to do work that brings purpose and meaning to my life forever. But unfortunately, the fact of the matter is the majority of today’s society (myself included) sets an alarm to go to their place of employment to earn money.
We trade time for money.
Are there people out there that would do their job for free?
Are there many?
You cannot do some forms of meaningful work without first having achieved financial independence. Volunteering full time is one example.
Other forms of meaningful work may actually turn a profit. Maybe you always wanted to have a go at that coffee business but could not afford the risk financially. FIRE opens up these doors and allows you to pursue your dreams that you wouldn’t have otherwise had the money to take on.
If you think that people who have achieved FIRE are phonies because they still do paid work I have great news for you! Turns out there is an entire group of you guys dedicated to upholding the semantics of the word retirement called the internet retirement police! At least you’re not the only one…
My interpretation of retire early was never about not working. It was always about retiring from the rat race and having the freedom to pursue meaningful work of my choice whether that is paid or unpaid doesn’t matter.
Retire is probably not the best word but FIRE is a catchy acronym and it’s stuck so just deal with it.
If you don’t like using the word retire that’s understandable. I myself have often thought that it doesn’t quite describe what FIRE is all about.
But what I think we can all agree on is that simply reaching FI should not be the end goal which brings me to discuss…
Why ER Is The Important Part
Think back to when you first discovered FIRE, or even just the concept of financial independence.
If you’re anything like me, the thought of having all the money in the world was not the exciting part. It’s what having that money could do for your life. The freedom that financial independence can grant is something that has never left my mind since I stumbled across it ~6 years ago.
Is there any point in reaching FI without using that freedom to live your dream life?
I know plenty of people at my old job who have reached FI but are still miserable in a job they don’t particularly enjoy!
You know the type.
Been at the same steady job with great benefits for 35+ years. Pretty conservative type operator who has tucked away enough Super to comfortably fund 4 retirements yet has lost all enthusiasm, motivation and what seems to be general happiness in the last few decades but still rocks up every Monday and complains the whole time.
You often wonder to yourself, why the f is old mate still working if he clearly isn’t happy here and has enough money to retire…?
That’s a very good question.
Maybe they are a creature of habit. Maybe they don’t know they are FI yet and think they still need to work. Maybe they are super conservative and are worried they will run out of money.
Or maybe they just don’t know anything else and are scared that they will lose purpose in life.
I have no idea about other peoples situation but if someone was truly FI and too scared to quit their job because they feared the unknown… they have missed the entire point of financial independence and FIRE in my opinion.
Everyone who reaches the end goal will always have to take a leap of faith of some sort. Maybe you have crunched the number for a standard 4% withdrawal rate or maybe you are a little more conservative and have opted for a 3% rate.
Regardless, all of us will reach the point where we will have to make the decision and hand in our resignation letter to start our new careers in the exclusive and more exciting field of ‘whatever makes me happy’. This career is not fueled by monetary gains, status symbols or power but rather what brings the most happiness to your life. If you get paid for this passion, sweet! Maybe you can donate this extra money to a charity which will almost certainly bring you even more happiness.
If you’re one of those lucky ones who thoroughly enjoys their current job and would happily work it for free then hats off to ya, you’ve already reached the end goal in terms of ER! I really wish everyone was in that position but the truth of the matter is they aren’t. And failing to RE to move onto more fulfilling, meaningful and enjoyable work is such a tragedy.
If you reach FI but continue working a job you don’t like and fail to RE, what’s the point?
Don’t Wait Until It’s Too Late
Just one more year…
Let’s tuck away just a little bit more so we definitely won’t run out of money in retirement…
This is a dangerous game to play but completely understandable and something that I’ll almost certainly do as well. But at some point we must trust our planning, numbers, and ability to adapt to the situation should something disastrous happen post rat race.
The biggest risk in life is not taking one!
Once you have reached FI, complete the journey, pull the trigger and RE to start the new chapter in your life.
I’ve haven’t heard too many people ever regretting pulling the trigger early, in fact, most say they should have done it earlier!
Have you retired yet? Did you wish you did it earlier or was it something you regretted? I’d love to know in the comment section below.
Oh and I’ve now decided that every good blog should have a sign-off.
Okay, so if you’ve been following me for any length of time you probably know that I’m a big fan of ETFs.
You know, those little exchange-traded funds that grant instant diversification with rock-bottom management fees to provide a great return for extremely little effort. It’s no wonder that famous investors like Warren Buffet and Mark Cuban (US billionaire) are also big fans.
Buffet has been quoted as saying:
“Consistently buy an S&P 500 low-cost index fund. I think it’s the thing that makes the most sense practically all of the time.”
I’ve been a big fan ever since reading the Bogleheads Guide to Investing about 3 years ago. And I put my money where my mouth is and currently have over $160K invested in ETFs.
“So if ETFs are so great, what the hell are LICs and why should I care? “
I’m so glad you asked.
Listed Investment Companies
FYI when I refer to LICs, I’m referring to the older ‘granddaddy‘ LICs like AFI, ARGO, Milton etc.
Listed Investment Companies (LICs) are first created by an initial public offering (IPO). Money is raised and a fixed number of shares are created for each investor. The money raised is then used for investing in assets such as a basket of shares which together make up the net asset value (NAV) of the LIC.
The shares of the LIC are traded on the stock exchange where investors are able to buy and sell when the market is open.
It should because, in a nutshell, ETFs are essentially doing the same thing. But there are key differences.
There may be more differences than what I’m about to go over, but the ones below are the key differences in my eyes and the ones that reflect my investing decisions.
ETFs tend to have a lower MER than the equivalent LIC but it’s not as bad as it sounds. If you stick to the older LICs (Argo, AFI, Milton etc.) the highest MER is around 0.18% which is not that bad. It’s still more than double that of an Australian index ETF such a BetaShares A200 (0.07%) though.
The management fees reflect the investment style of the two structures.
ETFs track an index or benchmark whereas LICs try to outperform the index. But given the low MER of the older LICs, some active management is acceptable in my view. I only have issues where the fund managers charge > 1.0% for their services.
WINNER: Generally ETFs
ETFs are a trust structure whereas LICs are a company as the name ‘Listed Investment Company‘ would imply.
This has some semi-big ramifications.
I’m going to try to keep to as simple as possible because we’re about to get technical here for a second.
To truly understand the differences between ETFs and LICs we must first understand how they operate and what’s the difference between Open-End and Closed-End
LICs are closed-ended.
This means that when the LIC had its IPO and raised the capital to start the company, a certain number of shares are issued. Once the company has been established and begins investing the capital on the behalf of shareholders, no more shares are issues. New investors wanting to join the LIC have to buy already issued shares on the exchange. The LIC does not create new shares to deal with demand.
Imagine a new LIC that has started with 4 investors each putting in $1. The LIC currently has a Net Asset Value (NAV) of $4 and there are 4 shares issued to each investor.
Those four shares that own the LIC are each worth $1 according to the NAV. But those shares are bought and sold on the market. And depending on how bullish or bearish the market is on Fake LIC, will determine how much the share price will drift away from its NAV value either up or down.
If someone offers 1 unit of Fake LIC for 80c, this is what’s called trading at a discount. If someone offers the same unit for $1.20 it’s known as trading at a premium. LICs can drift away from the actual NAV quite a bit.
Can LICs ever increase the number of shares? Yes, they can raise capital and issue new shares just like any other company but this only happens every so often and not something that’s done daily like ETFs.
ETFs, on the other hand, are open-ended and can create or redeem new shares in accordance with the market demand. If someone wants to enter the fund, they don’t need to trade with a current shareholder of the fund (like the LIC does). The fund can create a new share.
Conversely, if someone wants to cash out their share. The fund has to come up with a way to get the cash which may mean selling assets within the fund to give the investor their money.
But who sets the price of each unit?
When an Investor wants to buy or sell their units on the exchange, there is a market maker on the other side of the trade. The price they offer is generally very close to the Net Asset Value of the fund.
This is why you can’t really trade an ETF at a discount or premium to the NAV.
WINNER: LICs. The ability to trade at a discount is desirable but the company not having to sell assets during a crisis to meet demand is a big plus.
Traditionally ETFs track an index or benchmark whereas LICs try to outperform the index.
If you actually look into what is in the portfolios of Australian ETFs such as A200 or VAS and compare them with the old LICs, there is a lot of crossover. The whole active vs passive debate is more of a debate when the active fund managers are charging big fees (>1.0%).
I’ve got no issues with a little bit of active management as long as the MER is low. In fact, I like that most of the ‘Grand Daddy’ LICs have a focus on income. This is important to me and something that is reflected with historic returns for those LICs (more on that later).
One issue I do have with LICs is that they can and sometimes do change investment style. The fund manager that has a fantastic track record might retire or get offered a higher wage at another fund. I personally like the fact that most ETFs are legally obligated to track an index and can’t diverge from that strategy no matter what the managers are thinking.
Some would argue that being able to see waves in the market and adjust accordingly is a good thing.
WINNER: Tie. I prefer to track an index but don’t mind a little bit of active management as long as the fees are kept to a minimum.
ETFs are a trust and they must distribute their income each year to unitholders. The income from assets within the funds such as dividends, get passed directly from the fund to the unitholder.
Because LICs are a company, they can receive income from the assets they own (usually dividends from shares), pay the company tax rate of 30% and keep that income in the fund for as long as they want. Then at a later date, the manager can decide to pass it on, usually as a fully franked dividend to the shareholders of the LIC.
This means that the income from ETFs are often lumpy and inconsistent because the market may do well some years and bad others. But if the LIC retains some income from the good years, they can distribute it in those bad years to make it more smooth and consistent.
Sounds like a good thing right?
This one is something that’s been on my mind for a while.
The ‘smoothing’ of income is often touted as a benefit whenever any debate comes up between ETFs and LICs.
I beg to differ.
I personally don’t want the LIC to retain any of my income. I would much rather they pass on every single dollar to me so I can make the judgement call on what to do with it whether that be reinvested or spent.
This might be a plus to some but it’s an annoyance to me and something I really wish they didn’t do.
WINNER: ETFs. This is my personal preference.
Without going into too much detail, Dividend Substitution Share Plan (DSSP) and Bonus Share Plan (BSP) are offered by two LICs (AFIC and Whitefield respectively). It’s basically a plan offered by those two LICs which allow the investor to forgo the dividend in exchange for extra shares.
This means you don’t pay income tax and get more share instead. It’s great for high-income earners.
This is not offered by any ETF and is unique to the two LICs mentioned above.
This is actually not a difference but I want to clear up a common misconception about the franked dividends that LICs are able to pay out.
Some investors think that LICs can magically produce more income from the same basket of shares because they often pay out a fully franked dividend whereas an equivalent ETF might only distribute a partially franked dividend.
Let’s say for example that a LIC and an ETF both invested in the same company that paid out an 80% franked dividend of $70 dollars.
Here’s how that money would reach the investor using a LIC.
Note that the end result for this investor who is in the 37% tax bracket is a grossed-up dividend of $59.22 after tax.
So how does it play out in an ETF structure?
The end result for the investor is exactly the same. A grossed-up dividend of $59.22 after tax.
WINNER: Franking does not matter when comparing LICs to ETFs.
In a nutshell, the key differences are:
Management Fees (MER)
Net Asset Value (NAV)
As low as 0.04%
Passive. Usually tracks an index and does not seek to outperform.
Trades on, or very close to NAV
Although slightly higher for an equivalent ETF, the old LICs generally are all under around 0.18%.
Active. Seeks to outperform an index over the long term.
Can trade at a discount or premium to the NAV of the fund.
So Which One’s Better?
If you’ve made it this far, I can almost hear your cries.
‘Just tell me which ones better FFS!’
After consuming all that info above, you’ll be rewarded with a clear and concise answer as to which investment is superior and what you should do.
And here comes the most annoying answer…
They are both great.
Both have pros and cons but either ETFs or LICs are suitable for FIRE chaser in Australia looking to generate a passive income. The most important thing is to understand the pros and cons for yourself and then you can make an informed decision as everyone’s needs, investment style, and appetite for risk are different.
The last point is often overlooked, it’s not so much about trying to achieve the maximum return in my eyes. It’s about choosing a strategy that will generate that passive income but more importantly, a strategy that you’ll be comfortable with through thick and thin. Because any portfolio is easy to hold in a bull market (see negative gearing). But it’s when the shit hits the fan that you’ll really appreciate a well thought out strategy that you’ll feel comfortable in when everyone else is running for the exit.
ETFs and LICs are similar yet different. They shouldn’t be seen as enemies, more like best friends and depending on your mood, you might want to hang out with one or the other…maybe there’s room in your portfolio party for both?… Which leads me to talk about…
If you have read ‘Our Investing Strategy Explained‘, I have been thinking more and more about a dividend focussed portfolio which mainly consists of Aussie shares since they offer a great yield plus franking credits. They certainly feel like the ultimate passive investment to fund early retirement. And our end goal, after all, is to create a passive income stream to retire on.
So after much research, learning from other dividend focussed investors such as Peter Thornhill and Dave at Strong Money Australia and much toing and froing, I have decided to direct all future capital into high yielding Aussie shares in the form of ETFs and LICs.
We currently have nearly $100K in international securities which makes this decision a little bit easier. We are basically accepting the risk of lesser diversification in order to gain a higher dividend yield through Aussie shares.
I completely understand the risk and acknowledge that an internationally diversified portfolio will most likely outperform an all Aussie one in terms of total return. However, I’m confident in saying that the international portfolio will not offer the same level of dividend yield that the Aussie one will.
I would like to take a second to illustrate just how similar the returns are between most of the older LICs and Australian Index ETFs.
I’m going to be using the historical data of Vanguards VAS ETF because the A200 was only created this year and VAS has been around nearly 10 years. Since they are so similar it should be a fair comparison. And I’m choosing 4 of the most common older LICs for comparisons.
Below are the returns for investing $1M on the 21st of May 2009 (creation date for VAS) in each of the LICs and VAS.
It’s no surprise that the majority of the LICs returned more dividends than VAS. This is their main focus after all and a primary reason I’m investing in them.
Argo was a surprise returning significantly less than the others in terms of capital gains and dividends.
Maybe even more surprising is that VAS is smack bang in the middle of the pack for total returns. I guess that this just further illustrates that it’s hard to beat the index consistently over a long period of time. Some LICs might be able to do it (in this case MLT and BKI) but others won’t.
ETFs AND LICs?
Yes, I’m utilising a combination of an ETF and LICs for the Aussie portion of my portfolio which is what I have decided to focus on for the foreseeable future.
Here’s how it’s gonna work.
I will be purchasing either one of two LICs or one ETF once a month to the tune of around $5K.
Why 1 ETF and 2 LICs?
I have already been into why I think ETFs are so great if you’re looking to get exposure into the Aussie market and want to invest in an index style. BetaShares A200 or VAS are the obvious choices in my opinion and with the A200’s MER being half the price of VAS, it’s a clear choice for me.
One of the biggest pros for ETFs for me is that they do not try to pick winners and divulge from an indexing strategy.
LICs, on the other hand, can and do suffer from a fund manager change or investment style redirection.
This scares me.
To mitigate this risk, I’ll be spreading our capital out between two LICs even though what they’re investing in is incredibly similar and might look silly from a diversification point of view. But I don’t really care if others think it’s silly, if it helps me sleep at night then it’s all gravy baby!
The other reason I’m buying multiple LICs is to have a greater chance to be involved in a Dividend Substitution Share Plan.
So what am I buying and how am I deciding what to purchase?
A200 MER: 0.07% Benchmark: Solactive Australia 200 Index
Why it’s in our portfolio: BetaShares A200 made it’s way into our portfolio last month after Vanguard failed to respond and lower their management fee for VAS which is currently double that of the A200.
Given that the returns for the last decade between the ASX200 vs ASX300 (pictured below) were incredibly similar.
I’m choosing the ETF with the lower management fee every day of the week.
AFI MER: 0.14% Benchmark: XJOAI (ASX:200)
Why we will be investing: Other than being a dividend focussed LIC with a MER of 0.14%, AFI is only one of two LICs that offer DSSP. The other LIC is Whitefield (WHF) and that has a MER of 0.35% which is too high for my liking.
A very good detailed review about this LIC can be found by the ever so insightful SMA. Check it out.
MLT MER: 0.12% Benchmark: XOAI
Why we will be investing: Milton’s very low MER of 0.12% was attractive and we needed to spread our risk across another LIC so after much research, Milton it was. Milton also seems to be a bit more on the active side compared to the other older LICs which is another hedge against something happening with the index.
So if I’m going to be directing all future capital into Aussie shares through LICs and A200 ETF. When do I know which one to buy since they are all essentially the same investment (Aussie shares)?
Here’s what I’ll be doing each month when we have saved up $5K and are ready to invest:
Check both AFI and Milton’s NAV compared to their share price on the ASX to see if they are trading at a premium or discount (currently developing a web app to make this easier)
Invest in whichever LIC is trading at the biggest discount
If both LICs are trading at a premium, buy A200
That’s It…For Now
As of writing this article, for my circumstances and goals, I believe that an Australian based portfolio consisting of ETFs and LICs is the best strategy to produce a passive income for me to achieve financial independence so I can have the freedom to retire early.
But as I’ve always said, if I come across something that’s better than what I’m doing, I’ll make the switch.
My mind is always open to new ideas and strategies.
But that’s it for now… until strategy 4 rears its head 😈
If you follow any online FIRE blogger whether it be an Aussie or international, you might start to see a pattern that emerges more often than not.
The majority of these early retirees are living off an income stream generated by returns from Index Investing.
In this post, I’m going to go into detail about how I first started investing for financial independence and how my strategy evolved over the years.
In the Beginning
I first came across the term and concept of financial independence in a book called ‘Rich Dad Poor Dad’ by Robert Kiyosaki. It really struck a chord with me because it was so simple. You buy assets that make you money and eventually you will get to a point where you have so many assets that make so much money that you don’t have to work to live.
Mind = blown.
Now I was already pretty good at the saving and frugal part. But I had never invested in anything outside of a savings account. This leads me to pick up my next book in my quest towards FIRE, ‘From 0 To 130 Properties In 3.5 Years’ By Steve McKnight. Because if you live in Australia the most popular investing class by a country mile is without a doubt, Real Estate.
It makes sense too, most of our parents have seen/experienced incredible real estate booms without any real crashes in the last 25 years. My parents also invested in real estate so there was a comforting sense of guidance I could draw from when choosing this asset class. Mum and dad had been through it before and could mentor me.
Real estate is easy to grasp too. You buy a house, you rent it out and collect rent, the rent covers the expenses (hopefully), you sell it later at a higher price and make a profit. The other popular strategy with real estate is that you buy strong cash flow properties (where there is a surplus of rent after all expenses) and live off the rent, but this strategy is very hard to do in today’s market because of the low rental yields in Australia.
With time on my side for letting my investments grow for decades, my first investing strategy was to create an income stream through real estate.
Strategy 1 – Real Estate
The very first investing strategy I had, went something like this.
If I could buy 10 investment properties (IP) and hold them for 10 years, I could sell half of them and pay off all my debts. I would then have 5 houses pulling in rent with no interest repayments which would mean the majority would come to me.
The maths roughly looked like this:
Rent @ 5.2 Yield
10 X IP
And after 10 years, assuming that rent and expenses (but not interest repayments) have increased with inflation @ 2.5%
10 X IP
It’s important to note that while some expenses like rates, maintenance, water bills etc. would increase with inflation, the loan amount never changes. This is actually an advantage of leveraging your investments. You take out a loan in today’s dollars but can pay them off years later after inflation has eroded them. Which is often why you hear people say that debt is a good hedge against inflation.
And then I would sell 5 IPs and it would look like this
5 X IP
I was well on my way with this strategy and bought my third IP in 2015 which was around the same time as I discovered MMM and index investing which I will go into later.
This strategy has worked for thousands of Aussie and isn’t anything new.
So why did I decide to change my strategy?
Strategy 1 relies on capital growth.
You can see in the first table that there is nearly a $20K difference between the rent and expenses. What is not factored in here is negative gearing. All my properties right now are negatively geared but cash flow positive. Because of the tax refund I receive, the properties pay for themselves. But I could never actually retire off this cash flow which is why the capital gains are imperative. Without it, the strategy simply doesn’t work. And capital gains only works if someone buys your assets at a higher price than what you paid for it. I never felt comfortable breaking even or making a tiny profit each year with the hopes that 10 years down the track it would all pay off. I felt that investing should be a snowball approach where you start with a small trickle of passive income and see it grow into a raging torrent over the years.
There’s no way around it. Managing property requires time and effort. When I first started I had all the enthusiasm and motivation in the world and wanted to do everything I could to reach FIRE as quickly as possible. If that meant some sweat equity then I was all for it. But roughly 5 years later my motivation for doing all the extra stuff has fallen off a cliff. I would much rather focus on other things than worrying about and managing my investments. To be fair, my properties aren’t too much of a hassle, but getting to 10 IPs would be a lot.
Lending conditions changed
It was around about 2016 when the APRA (Australian Prudential Regulation Authority) really made it hard for investors to withdraw equity and refinance their loans. This was to try and curb risky lending and make it harder for property investors. Interest rates were raised on all of my loans and the number of hoops I had to jump through for my last equity withdrawal was 10 times harder than in 2014 and 2015. Looking back now, I was very fortunate to get into property when I did. Interest rates were being cut and banks were financing loans a lot easier. In mid-2016 I could not get another loan for a 4th property which meant my dream of 10 properties was out of reach.
But if I’m not going to reach financial independence through real estate, then how else am I going to create a passive income stream?
Strategy 2 – Index Investing
I think I can speak for a lot of people when I say Mr. Money Mustache has a way of writing that people relate to. I guess it’s why he is so popular. When I read The Shockingly Simple Math Behind Early Retirement it just made sense. And his article about Index Investing really clicked with me and would be what I consider the catalyst for my desire to learn more about the stock market.
It’s quite funny to see peoples reactions when they discover you have 6 figure sums invested in the stock market.
“That’s so risky though. Don’t you ever get scared you’re going to lose it all? One minute it’s there, next it just vanishes. I wouldn’t feel safe having so much money in the stock market, I only invest in things I can see and touch.”
I too once thought like this because of the constant news outlets reporting on the stock market crashes and how billions were wiped out in mere hours. Scary stuff.
But if you actually take the time to understand how the stock market works and what index investing is, I think you would be pleasantly surprised to find out all the positives that come with this investing approach.
What is an Index?
Indices cover almost every industry sector and asset class, including Australian and international shares, property, bonds, and cash. There are companies that conduct and publish financial research and analysis on stocks, bonds, and commodities to create indices. One of the more popular companies that publish these indices is Standard & Poor’s (S&P).
Have you ever listened to the news and heard them talk about the All Ordinaries (also know as All Ords) and wondered what it is? The All Ords is Australia’s oldest index of shares and consist of the 500 largest companies by market capitalization.
Let’s take a look at the S&P/ASX 200 (top 200 companies trading on the ASX by market cap) historic data since 1992:
Here is the Dow Jones (US index) for around the last 60 years.
And lastly, here is the Financial Times Stock Exchange (FTSE) 100 Index which is the top 100 companies listed on the London Stock Exchange by market cap.
What is Index Investing?
You might notice a few trends from the above graphs like the dot-com crash around 1999 to 2003, or the GFC in 2008 or the constant peaks and troughs through the years.
But what is glaringly obvious is the overall trend in each countries index is up.
And these graphs don’t include the most important part. The entire time throughout these decades, those companies that are trending up or down, are paying dividends (or reinvesting them) each year! So combine the capital growth from the above graphs with dividends and you get the idea. The overall markets, given enough time, trend upwards!
This is a fundamental principle of index investing.
It’s hard to predict which companies are going to do well over the next 20-30 years. In fact, it’s almost impossible. A lot of active fund managers try to outperform the index and charge you exuberant management fees with the promise of higher returns. The thinking behind this makes enough sense. The fund managers have an army of analysts working 12 hour days using the latest analytical tools and datasets to ensure that they only choose the ‘best’ companies to invest your money in. But as history has shown, only a very small % of investors/fund managers are able to consistently over a long period of time (20 years+) beat the index.
Rather than trying to guess which investments will outperform in the future, index managers replicate a particular market or sector. This means they invest in all or most of the securities in the index.
Indexing is based on the theory that investors as a group cannot beat the market – because they are the market.
So how do you invest in an entire index?
You could, in theory, buy all the companies within an index at the appropriate weightings. You would get killed in brokerage fees but I guess technically you could do it. But luckily there’s a much easier way.
There exists investment companies that cater to the index investing style and offer investment products that mimic an index with rock-bottom management fees. One of the biggest investment companies that offer these products is Vanguard.
The reason Vanguard and other companies can offer these products at such a low cost is that there is no money spent researching and analyzing which stocks to invest in. Index investing companies simply look at the index data provided by companies such as S&P and remove or add companies from the index plus a bit of paperwork. That’s it!
To put the management fees into perspective, a hedge fund’s fees might be as high as 2.00%. Vanguard charges me 0.04% for my US index ETF that I invest in.
To put it another way, if I had $1M in the hedge fund. They would charge me $20K a year for management fees. Vanguard would charge me $400 bucks. The difference of $19,600 reinvested at 8% over 30 years is $2.4 Million!!!
You can either invest directly with the Vanguards fund or you can buy ETFs which are exactly the same investment products but traded on the stock exchange. There is also a difference in management fees. You can read up a bit more about the difference in this article How To Buy ETFs.
Why We Decided To Move To Index Investing
I joined finances with my partner in 2016 and we made the decision to start investing in ETFs (index investing). After reviewing the two asset classes a year later, we knew that we wanted to continue to go down the path of index investing. Here are the reasons why we decided to move away from real estate:
With our current three fund portfolio, we have exposure to over 6,000 companies in over 30 different countries. Our three properties are all located within Australia (different states mind you) and while I think it’s unlikely that they would all tank at the same time there is the possibility of a recession to hit Australia. If that were the case, those properties would almost certainly drop in value. And Investing Strategy 1 relies on capital gains to work. If something like that did happen, they have enough cash flow to make it through but who knows how long it might take for them to recover and ultimately gain enough value for the strategy to work. I might be waiting for decades.
The odds of the entire world tanking over a long period of time is not completely out of the realms of possibilities, but it’s a lot less likely than one country going into recession.
If we ever needed the money that was locked in the properties. It might take 6+ months to sell them and go through the whole process. With ETFs, I can put in a sell order and literally have the money in my account within 3 days. This means that selling off parts of your portfolio to fund your retirement is possible.
This is probably the biggest reason why we made the move. The path towards freedom is a lot clearer with ETFs. We know that we will need roughly $1 million in the market to generate enough returns each year to live off forever. The high cash flow/liquidity makes index investing a popular choice for FIRE chasers.
No more banks
Investing in ETFs does not require lengthy loaning processes. Leverage can have its place but it’s not required.
Some may argue that real estate can be passive, and to some degree, I guess it is. But from my experiences with real estate, such jobs as collecting rent, doing paperwork, dealing with tenants, responding to emails, maintaining the properties etc. can add up to be a part-time job. You will not find a more passive income stream with the same returns as what ETFs offer. And I also love the fact that the more ETFs you have does not mean more work. More properties = more work. But you will do the same amount of paperwork come tax time on a $50K portfolio vs a $3M one.
I don’t have to be an expert
I believe that you need to know your shit when investing in real estate. I wouldn’t be comfortable investing in a property unless I knew the ins and outs of the area like the back of my hand. Where are the jobs coming from? What’s the population growth like? What’s the unemployment rate like? And on and on I could go.
The only thing I have to work out each time I buy ETFs is what I need to buy to rebalance my portfolio. That’s it! I don’t need to keep up to date with the latest trends or what’s the hot stock right now or any of that crap.
Our Plan Detailed
If you read my monthly net worth posts you can see that we invest in a three-fund portfolio. I’m going to go into details about why we invest in each fund and how ultimately they will enable us to reach FIRE.
Management Fees: I prioritize a low MER (Management Expense Ratio aka management fees) above almost everything else because paying less in management fees is a guaranteed returned and when it comes to investing in general, almost everything else is speculation to a certain degree.
Given my obsession with management fees, you can understand that Vanguard was an easy choice as an ETF provider since they offer some of the lowest MERs in Australia.
This is what our Strategy 2 looks like in pie form
Let me explain each fund and why it’s in our portfolio
VAS MER: 0.14% Benchmark: S&P/ASX 300 Index
Why it’s in our portfolio:
Some people will argue that Australia is such a small percentage of the world’s markets (around 2% last time I checked) that it’s not diversified enough and you’re better off going global for that diversification. I generally agree with that and what’s even worse is that out of my three funds, VAS has the highest MER at 0.14%.
Australian companies for whatever reason emphasize higher dividends vs capital growth. I’m not 100% sure why this is, but please feel free to let me know in the comments for all those smarty pants out there. Anyway, this high dividends plus franking credits means that VAS pumps out a solid stream of dividends each year. The franking credits are too good of an opportunity to pass upon and are why VAS takes up 40% of our portfolio.
It is essentially the same product as Vanguards VAS ETF except the A200 invests in the top 200 companies of the ASX instead of the top 300. Something to note is that the bottom 100 companies in VAS only make up 2.5% of the total in terms of market cap. So while the A200 is less diversified than VAS, it’s not as bad as it sounds.
The A200 boasts a MER of just 0.07%.
That’s half the price in management fees vs VAS!
I will be moving to the A200 if Vanguard does not respond with a lower MER next time we buy.
No one knows if VAS is going to outperform A200 moving forward. But what we all know, is that right now you will be paying double the price in management fees if you invest with VAS.
I won’t sell VAS moving forward, but I will be buying A200 instead.
VTS MER: 0.04% Benchmark: CRSP US Total Market Index
Why it’s in our portfolio: Diversification? Tick (the US make up around 40% of the entire world market)
Good Returns? Tick
Rock bottom MER? Tick!
How can you possibly go past this ETF if you’re looking for a low-cost diversified ETF? At 0.04%, that’s the lowest management fee of any ASX ETF I can think of off the top of my head. I have often thought about going 100% VTS because I value a low MER with the highest regard. But the franking credits keep pulling me back to VAS and complete world exposure is why we finish with VEU.
VEU MER: 0.11% Benchmark: FTSE All-World ex US Index
Why it’s in our portfolio: VEU rounds off our diversification by giving us the entire world minus the US at a very reasonable MER of 0.11%. And since we also invest in VTS, this means that with just three funds, we have exposure to the largest companies on planet earth.
Think about what would need to happen for us to lose all our money. Companies like Apple, Microsoft, Google, Exxon, Facebook, Commonwealth Bank, ANZ, Westpac, Shell, Samsung, Toyota, GM Motors, Telstra, Johnson & Johnson etc. would all have to go bust. All of them! I just can’t see that happening. And if some of those companies do go down the drain, they are simply replaced in the index by the next company with the highest market cap. And because the index is only giving a small weighting to individual companies (less than 1%), you won’t see it affect your portfolio. The only time a significant drop occurs is when the entire market as a whole is down (like what happened in 2008).
The 4% rule
The 4% rule is based on the 1998 paper called the Trinity Study and to put it simply, it means you should, in theory, be able to live off 4% of your portfolio. It’s an American study and is meant to last for 30 years so it’s not full proof by any means. But this is what we are using when calculating ‘our’ financial independence number.
So if we have a portfolio of $1M, we could live on $40K a year and never run out of money (it also factors in inflation).
How Much Do We Need?
We are currently on track for this F/Y to have spent a touch under $50K. That’s absolutely everything we spend to live our current life. It also factors in rent.
We do plan to own our own home one day which means that factoring in a fully paid off house, we spend about $38K a year.
Which would mean that we need a fully paid off house plus $950,000 in ETFs to generate enough income each year (factoring in inflation) to become financially independent! But being on the conservative side of things, I think a cool one million will be the target.
How It’s Going To Work
Let’s imagine, for argument’s sake, that we had reached our $1M portfolio goal with all the appropriate weightings for VAS (40%), VTS (30%), and VEU (30%) exactly one year ago (19/06/2017).
After one year, this is what the performance of that portfolio would look like thanks to ShareSights amazing ability to create dummy portfolios with historical data.
And if we look at how each fund performed for the last 12 months we get this.
Total Return for the 3 funds was $131,276 for the last 12 months!!!
A few things to remember though:
We need to factor in inflation. If we assume 2.5%, that means that our real return was $127,964.
The last few years have basically been a bull run for the whole world. This portfolio is not going to return these numbers every year. But that’s ok, what we need to do in the good years is not spend extra, but keep that surplus in the portfolio so when the bear market does come (and it will) there is enough to carry us through to the next bull.
By looking at the total return, it would appear that VEU did really bad and VTS did really well. But how we actually should measure the returns is in percentage. Which looks like this
VAS and VEU are a lot closer when comparing % returns. VAS has a higher weighting which is why it returns more dollars when it’s very close in percentage terms.
We are aiming to achieve around an 8% return on average from the stock market. So 13.13% is a fantastic year!
The Dividend Part
You can see from the above graph that we received $34,265 from dividends in 12 months… This is pretty good but you can clearly see from the fund breakdown where the majority of the dividends came from. VAS of course. Australian shares just pump out those juicy franked dividends like no other which is great.
But what’s probably even more important to note, is how low the dividends were for VEU and especially VTS considering VTS made an overall gain of 18.92%! You won’t get much better than that and it still only paid out a lousy 1.83% yield.
We needed $38K last year. But this year inflation (2.5%) adds another $950 dollars. So we now need $38,950 to maintain our lifestyle.
The dividends cover $34,265, which means we’re short $4,685.
The Captial Gains Part
You know how I was just bagging out VTS because of its putrid dividend yield? Well, boy does it make up for it in the capital gains department!
VTS alone smashed our FIRE number of $38,950 and returned a whopping $51,295 (17.09% Gain!!!). Combine the other two funds and last year well and truly exceeded the 4% rule.
But how do we harvest these capital gains to actually live? The dividends are straightforward because they are paid directly into your account without you having to do anything. The capital gains part is a tad different.
We need to sell off units from our portfolio and realize a capital gain.
This is the part where a lot of people either don’t fully understand or are not comfortable with.
“Wait, I thought we reach a certain size portfolio and it pumps out a passive income stream we can live off? I don’t want to sell part of my portfolio. What happens if I have to sell it all”
It’s perfectly fine to sell off parts of your portfolio as long as it has the time to recover those losses.
For example, in the above scenario, I need an extra $4,685 which I must get from selling some units from one of the three funds or parts of all of them.
The most obvious fund to sell some units is VTS because it had the best return in the capital gains department and we can lock in those profits by selling. Each unit is now worth $193.190. So a bit of quick maths means I need to sell 24.25 units. Rounding it off and factoring in brokerage fees lets just say we sell 25 units.
$193.19 X 25 = $4,829
We have now made up what we needed to live for that year.
“But we are now down 25 units right?”… Technically right, but the wrong way to look at it.
Firstly, the portfolio grew by $131,276 dollars. We took $38,950 out of that growth to live on which leaves us still up $92,326. When next year rolls around, because of the power of compound interest, it doesn’t matter that we are 25 units down. Assuming we get the exact same returns in percentage terms, we will make more money next year because the starting value of our portfolio is higher than last year even factoring in 25 fewer units.
“But what if I run out of units?”
Highly unlikely. Each year you will have less and less units, but those units should be worth more unless it’s a bad bear market. Even so, we will have over 11,000 units spread across the 3 funds. Every few years they will be worth more and more meaning we will have to sell fewer units each time to make up the difference.
What Happens If We Retire And Another GFC Hits
This is the worst case scenario for our plan. Because it relies partly on capital gains, a huge downturn in the market straight after we pull the pin would mean we potentially would have to sell units at a rock bottom prices. And it’s possible that our portfolio might shrink too much in the early years and never make a full recovery when the bull markets come back around.
In this situation, I think the answer is pretty obvious.
At absolute worst, I’ll pick up some part-time work. Shit, even 200-300 bucks extra a week would dramatically reduce our reliance on ETFs. $300 a week for a year is over $15K which is 40% of our expenses!
When our portfolio reaches $1M and we have the house fully paid off, I will at that point, declare financial independence.
But what will we then do?
If we are enjoying our lives to the fullest, then there would be no reason to change anything. But what I most likely will do immediately is drop my working days down to 2-3 days a week. From there the possibilities are really endless. Do I want to continue working at my current job? Maybe I only want to do part of my job 2 days a week? Maybe my boss won’t like that, but since I have reached FIRE I will have the power to quit my job without worrying at all.
I don’t plan to ever stop working, to be honest. It will just be 100% enjoyable work and probably not full time unless it’s a passion project. So the odds of neither Mrs. Firebug or I receiving some form of income post retirement is extremely low. This blog is even pulling in some $$$ now and I absolutely love working on it. I couldn’t imagine where it could go if I worked full time on it!
We will always have the portfolio there knowing we are financially independent, but there’s a good chance we will still earn some form of income from something fun 🙂
Ok, long read so far I know. But we’re nearly there.
I’m a big believer in the following quote:
I’m constantly looking for new ways to invest, reduce our spendings, find tax efficient methods etc. It’s half the reason I started this blog. So a whole bunch of people way smarter than me could critique my strategies and explain better ways to do things. And it’s worked an absolute treat so far. The Australian FIRE community is the best for sharing information that will help you get wealthy a lot quicker than if you had gone at it alone.
So when I come across something that makes sense to me and is even better than what I’m currently doing. Why wouldn’t I adopt it?
The entire reason I invest money is to reach the end goal of financial independence.
To have my assets generate enough income for my partner and I to live off forever.
The key word here is income. In Strategy 2, capital gains are still required because VTS and VEU predominately return capital gains vs dividends. VAS is the cash flow king out of the three because that’s the Australian index and Australia has a high rate of dividends.
Peter Thornhill is the author of the best seller ‘Motivated Money’ which details his investment approach to investing for dividends (mainly in the industrial sector) and not for capital growth.
He explains in his book that dividends are a lot more stable and less impacted by market swings as opposed to the share price. Something that really struck a chord with me is the way he explains intrinsic value. In a nutshell, the real value of a company or any investment, in general, should be determined by how much income it is able to produce over a long period of time. It’s the income that is key. And it’s the income that will either pay the investor (you) the dividend or be retained by the company and consequently have the share prices go up.
This is how it should work, but as we all know. Humans tend to speculate a lot and you end up with assets that have potential but no solid foundation of cash flow being traded for ludicrous amounts of money (BitCoin, Sydney Real Estate etc.).
I’m not saying these assets don’t have value, but the only way that an investor can make a decent return is if they find someone that is willing to buy it at a higher price than what they paid for it.
If the goal is income, why don’t we focus only on investments that yield the best dividends?
Why not go 100% Australian stocks?
Australian shares yield the best dividends AND they give you the bonus of franking credits. These two reasons make a very appealing case for any Aussie investor.
I encourage everyone to read Thornhill’s book ‘Motivated Money’ because he explains the dividend approach a lot better than I can.
Here is a little video of Peter explaining why he looks forward to a GFC event.
The more I listen to this guy, the more convinced I am with his approach to investing in Australia.
“Watching the share prices drop is a totally different thing to the cash flow that’s coming out of the portfolio. That is what we are living on, we are not living using the capital as the source of income, it’s generating the income for us” -Peter Thornhill
Hopefully, you can come away from this post with a much clearer understanding of how we are planning to reach FIRE in the next coming years. I really wanted to include as much detail in this as possible and try to convey our thoughts behind the investment decisions we are making.
I think it’s common for a lot of Australians to start with real estate but finish with shares. I feel like that is the natural progression that as we get older and don’t have the time or energy required for active investing, the share markets offer a fantastic passive alternative with many other benefits. We are on track with strategy 2 at the moment. But the more I think about strategy 3, the more I’m liking it.
$1M is our official FIRE number. When we reach that plus a house paid off, the goal will be reached. It’s still a few years away no doubt, but we are enjoying the journey and each month we move closer to our destination.
What about your strategy? Are you on a similar path? I would love to hear about how you’re going to reach financial independence in the comment section below.