Aussie Firebug

Financial Independence Retire Early

Australia FIRE Survey Results 2020

Australia FIRE Survey Results 2020

Welcome to the very first Aussie FIRE Survey results!

Firstly, I know that half you guys read this blog on your phone but if you can, please come back to this post on a desktop or something with a bigger screen because the visuals look so much better and the dashboard was designed to be viewed on a desktop.

I’m really keen to run this at the start of every year and release the results along with the dataset for the wider community. I was inspired by the extremely popular Stack Overflow Annual Developer Survey Results that they publish each year for developers. Essentially, you can read where people are from, what technology is used the most in the community, what coding languages are hated the most and a whole bunch of generally interesting tidbits.

I had this idea mulling in the back of my head for years and thought wouldn’t it be cool to run an Aussie FIRE Survey each year and share the results! One of the greatest strengths of this community is that we are willing to share and talk about what is normally considered taboo subjects. I’m probably on the extreme end of the scale of what people are willing to share but the beauty of the survey is that anyone can fill it in completely anonymously.

The results below are both extremely fascinating and interesting. What I also hope that this annual survey can achieve is to give a little bit more help to would-be Firebugs who are trying to start their journey but don’t have a measuring stick.

Think about it, if you read something online about person X saving $30K a year and investing in VTS without any context, you don’t really know if that’s a lot of money for them (they could be earning $250k per annum) and what their circumstances are that made them choose that ETF.

At the bottom of this page is the FIRE survey dashboard where you can slice and dice the data to suit your needs. The richer this dataset gets, the more specific you guys will be able to drill down to your situations and get a feel as to where the rest of the community is at. You might be a 28-year-old single lad from Melbourne that’s earning between $80K-$100K. It might be of great interest to know what others in your situation are doing/are at with their journey.

That’s the idea anyway. I sorta stuffed up the survey when I ran it in March because I forgot to include some key questions (like super šŸ™ˆ) but I already have a heap of improvements I will make when I open up the survey again at the end of this year.

The survey had 654 submissions across 9 countries and theĀ results are broken up into four sections:

  1. Firebug Profile
  2. Investing
  3. Miscellaneous
  4. FIRE Dashboard (interactive dashboard using the data from the survey)
  5. Methodology

Feel free to download the raw data from here (Open Database License (ODbL)).

Please tell me what questions you’d like to see in the future version of the survey and just general tips or recommendations for me šŸ‘

Enjoy!

 

Firebug Profile


Geography

 


*This map may not rendering on mobile phone screens

There was no surprise that the majority (621) of submissions came from Australia. I was actually shocked that 8 other countries contributed. I’d love for this survey and the results to become more global in the future.

I was pleased to see my home state of Victoria coming though with the most submissions for the Aussies šŸ¤˜
 
 
Age Range

No surprises here. I knew from my Google analytics that the majority of my audience fell between 20-40 years of age.

 
 
Sex

I'm currently working on some content that's more female focussed because finance and investing seem to be heavily skewed towards a male audience.

 
 
Relationship Status

I was thinking about FIRE for singles just the other day. It's definitely possible but a lot harder to do. Take our situation living in London for example. We pay Ā£900 a month in rent that gets us a bedroom with an ensuite. Everyone else in the house pays around Ā£700 and they have to share the downstairs communal shower. All the big-ticket items like living, food and transport costs can be shared between a couple whereas you're paying for everything if you're single.

 
 
Kids

Considering the age range that filled out this survey this result doesn't surprise me too much.

Was a bit surprised to see so many maybes tbh.

 
 
Education

Close to 70% of the respondents are university-educated šŸŽ“. No wonder so many smart people live in the comment section!

 
 
Employment Status

 
 
What industry do you work in?

This one is super interesting because there seems to be a lot of people in the tech industry that are drawn to the concept of FIRE (I fall into that stereotype šŸ™‹ā€ā™‚ļø). But the data is showing a lot of diversity! I probably could have guessed the top two categories but the rest was very interesting to see.

 
 
Annual Household Income (after-tax)

Holy moly some of you guys are earning a mint! I'll have to add more upper tiers in income for the next survey since the highest submission was for $195K+ šŸ¤‘

 
 
Net worth (excluding your home equity)

So the way I interpret the above data is that there must be a lot of people either at the start of their journey building up a solid snowball of around $50K-$200K and also a lot close to the end in the $1M+ range.

 
 
Living Status


I would have guessed the renters were going to take out šŸ„‡ place here actually.

 

Investing


Have you reached FIRE?

 
 
How many years have you been investing for?

 
 
Financial Planner?
 

 
 
Top 10 ASX listed products owned

 
 
DRP/DSSP
 


I was a little surprised at how many people use DSSP actually.

 
 
How do you own your investments

 

Miscellaneous


Top 10 banks respondents hold their mortgages with

 
 
Side Hustles
 

Please note that the below figures are the annual median income after tax and not the averages. There were a few massive submissions that would have blown out the average completely so median seemed to be more appropriate.


hmmmm I think I need to get into Amazon FBA šŸ˜‚

FIRE Dashboard


Here is what I believe to be the very first interactive FIRE dashboard generated from user data... ever!

There's probably someone out there that's already made one but I've never seen it. I'm really happy how the dashboard turned out and it's only going to get better each year as I add enhancements and features. The more people fill out the survey the richer the dataset will become which will make the insights and analysis more accurate.

Most things in the dashboard are interactive. You have the filters at the top but you can also click on each visual and it will affect the others.

Here's a quick little video explaining how it works.

I'd highly recommend viewing the dashboard in it's fullscreen mode. If you're on your mobile, please come back to this bad boy on a desktop. Trust me... it's worth it šŸ˜

Feel free to have play with the PowerBI file here. There were some assumptions made in the dashboard but if you're interested in how the data was put together, the PowerBI file has everything you need.

Methodology


This report is based on a survey of 654 Firebugs from 9 countries around the world.
 

    • The survey was fielded from the April 5 to May 1 2020.
    • Unfortunately there wasn't a timed component in the dataset which means I could not qualify responses. I plan to add a timer for the next survey to fix this.
    • Respondents were recruited primarily through channels owned/ran by aussiefirebug.com which included: Aussie FIRE Discussion Facebook group, Aussie Firebug Twitter Account and Aussie Firebug Blog
    • All income figures are based on AUD. There will be changes to this in future surveys as I'm aware international salaries should ideally be converted to a base currency
    • Net worth figures are in AUD
    • Some visuals do not always take into consideration all the answers due to visual issues. There were 87 distinct values for banks for example. Reducing that to a top 10 is more visually appealing. You can always download the entire dataset if you want to know all the submissions.
Election Results & Strategy… 2.5?

Election Results & Strategy… 2.5?

In case ya missed it, earlier this year I published what turned out to be my most controversial article of all time (and it’s not even close). The Curious Case of Franking Credits and the FIRE Community of course.

The thing is, I actually really don’t like talking about politicians and what they say and plan to do at all. That piece was never meant to be political but after reflecting for some time now, it was always going to be that way due to the nature of the subject matter.

So why the hell would I ever go near it again?

Because even though I don’t like those šŸ¤”, politicians do affect us in the journey to FIRE and I need to set the scene first in order to talk about how we come to the conclusion at the end and where we’re heading moving forward.

And the beauty of having your own blog is you get to write and publish whatever you want. I create content from my point of view and never claimed my writing was balanced. This site isn’t the ABC or some neutral FIRE outlet. I presented facts in that article with my opinion which I understand everyone isn’t going to agree with.

However, that topic was interesting to me (and a bunch of others) so if I’m offending you or you don’t like what I’m writing, maybe you should follow another FIRE blogger āœŒ

 

Franking Refunds Survived…For Now

Like Steven Bradbury before him, ScoMo and the Coalition skated past the ALP for a come from behind victory and with it, the franking credit refunds will remain for the foreseeable future.

This was a hot topic amongst the FIRE community and now that the election has passed, it seems like things should proceed as per normal right?

I mean, franking credit refunds didn’t get the chop so fully franked dividends are safe to retire on yeah…?

Well… about that

Whilst I think that the result of the election speaks volumes to where the majority of Australians priorities lie, I strongly believe that a lot of the policies the ALP were trying to win votes on will not be touched for a very, very long time. They were aggressive with their tax reforms, franking credit refunds being one of the smaller changes (CGT and trust distributions being a lot bigger).

This was supposedly the unlosable election for the ALP. Every poll in the country had them winning by a landslide. Sportbet even paid out on them winning two days early to the tune of 1.3M šŸ˜®

For them to lose in the fashion they did, especially after all the shit the Coalition has done during its previous term tells me that the majority of Australians did not agree with the policies they were proposing.

And it’s my opinion that aggressive tax reforms played a huge part!

Now I’m definitely not an expert on this subject and don’t know for sure (no one really does) but I doubt we will see such aggressive policies proposed by any party for some time. I’d almost bank on it that scraping franking credit refunds will not even be thought about in the next election. They’ll go after something else, that’s a given. But it won’t be the same policies that contributed to them losing the election this year.

Sidebar: I’m not here to talk about the policies or politics so for the love of God don’t @ me in the comments about it.

But that’s enough about the election.

Again, I really don’t like politicians in general and try to avoid talking about them as much as possible. I only bring them up because it’s important to set the scene for the decisions we’re making in regards to investing for financial independence which is what this blog is all about.

Which brings me back to the point about the franking credit refunds.

Whilst I truly don’t think any political party will go near them for a very long time. I also learnt something very valuable from that campaign policy.

The legislation risk associated with franking credits in general.

I was completely naive in thinking the government would not pull the rug out from underneath us and the refunds would be here to stay.

What a fool I am!

I’m just thankful we’re still in the accumulation phase and have a chance to mitigate this risk a bit moving forward (more on this below).

But wouldn’t it have absolutely sucked if you’d worked your whole life and built up a retirement fund utilizing franking credit refunds only for the government to turn around and change the rules on you!

The refunds are safe for now. But I plan to be retired for 50+ years. That’s a long time for people to forget what happened in 2019 and if I were a betting man, I’d wager that sooner or later, franking credit refunds will be back on the chopping block!

 

Are Aussie Shares Worth It Without Franking Credits?

The thing about franking credits for those who are chasing FIRE in Australia is that without the refund, they are worth a hell of a lot less and in some cases, will mean that you don’t receive any benefit from the franking credits at all.

Let me give you an example.

Mrs FB and I know that to fund our current lifestyle in Australia, we spend around $48K over the course of 12 months.

We plan to own a house one day, so if we remove our rent and add on a bit to cover rates, maintenance on the property, insurance etc, we get to around ~$42K at a guess.

The plan before the election was for us to split our dividend income 50-50 and pay ourselves the $18,200 (tax-free income threshold) each from Aussie franked dividends. Let’s assume that the dividends are fully franked.

We each would receive $18,200 in cash throughout the year plus $7,800 in franking credits each. This means that the ATO would look at us having a taxable income of $26,000 for that year (dividend plus the FC).

Here’s the math behind the grossed-up dividend.

Dividend % Franking Franking Credit Tax Before FC Tax After FC Grossed up dividend
$18,200 100% $7,800.00 $1,482 -$6,318 $24,518.00

The franking credits soaked up the owed tax of $1,482. This will still happen if the refunds were ever removed.

But more importantly, the franking credits refunded us $6,318!

Because we, as the shareholder, have already pre-paid tax @ 30% that was removed from the dividend before it hit our accounts. It’s only fair that this is recorded (the franking credit) and the ATO is aware of us pre-paying the tax so we can be refunded later if we paid too much tax for that year which in this example, we did.

This was always the intention of imputation credits. Not to only stop double taxation (which consequently it also does), but to ensure that income is taxed once by those obliged to pay it.

So the end result is around $24.5K each to fund our life after retirement.

That’s almost $50K! More than enough for us to live comfortably forever whilst factoring in inflation.

But if we remove the refund. We only end up with $36K between us.

That’s a whopping $13,036 dollars difference and means we need to head back to work.Ā 

Or let me put it to you another way. You’re losing 28% of your return šŸ’ø

 

Tipping Point

I was on the fence for a long time before moving towards an Aussie dividend approach with Strategy 3.

A lot of people out there don’t realise that a major part of the dividend approach for me was not about total return. In fact, I even mentioned it in Strategy 3 that if I were to guess, I’d wager that Strategy 3 would slightly delay my FIRE date because of the less efficient tax method of income (dividends are less efficient vs capital gains) and less diversification.

We moved to Strategy 3 predominately because of the psychological aspect of receiving income that was not affected as greatly by human emotion (share prices) and is more anchored to business fundamentals (income of a profitable business that is passed to the shareholder via a dividend).

There have been great Australian based articles written that objectively looks at retiring on dividends vs capital growth and I constantly receive messages that link to studies showing superior returns for an internationally diversified low-cost ETF portfolio.

Guys, I’m a die-hard FIRE fanatic,

I’ve come across most of these theories and articles before! What’s missing here is the human element. We’re not investing robots. I’m not too fussed between minor differences in returns and place great value in simplicity and sleep at night factor.

I thought the trade-off of less international diversification and a slightly delayed FIRE date was worth retiring on dividends vs dividends + capital gains.

But everyone has their tipping point.

Without the franking credit refund, Aussie shares just don’t cut the mustard IMO.

The difference is just not worth it for us. But everyone’s circumstances are different.

For instance, those looking to retire on FATFIRE will not be as greatly affected by this change since they will have more of an income to soak up those credits.

And many people have rightly suggested to me that there are a lot of alternative strategies to generate unfranked income such as REITs, Bonds, P2P lending etc.

These are viable alternatives for some, but we want to continue investing in companies for now.

 

Mitigating Risks

Let me be quite clear.

I’m still a massive fan of the dividend approach.

But placing such an enormous amount of faith that politicians won’t change the rules around franking credits over the next 50 years just doesn’t seem logical to me.

I want to mitigate the legislation risk of a potential franking credit refund axing as much as possible but at the same time, continue our overarching investment philosophy of investing in great companies.

We want to reduce our portfolios franked dividends and take advantage of a more diversified portfolio again. Which means…

I kept the international part of our portfolio when we decided to focus on Aussie shares. And when the very real news of potential changes in franking refunds was mentioned, I felt such a huge sigh of relief knowing we still had some international exposure. I guess this just goes to show the power of international diversification. If one country stuffs something up, there’s plenty more out there so you’re covered… doesn’t really work if you’re all in on the one country though šŸ˜…

Given that I don’t think franking credits refunds will be there over the next 50 years (no refund for us basically means no credits at all). I would like to receive some income from international companies along the way. It’s not going to be as good as the Aussie yield, but it helps the situation and my sleep at night factor.

Also, with the help of capital gains, an internationally diversified portfolio according to almost every major study done of the subject, will reduce risk, volatility and increase safer withdrawal rates!

 

To LIC or Not To LIC?

This one’s quite straightforward. A LIC has to pay a fully franked dividend. An ETF does not. VAS, for example, has a franking % of around 70-80 % which means that part of the income is not franked.

As I detailed in my ETFs vs LICS article, they are so similar that we are basically splitting hairs when comparing the two. As such, the greater legislation risk associated with LICs to me has shifted my favour towards ETFs.

I want to make myself clear again. I’m still a fan of LICs. I love the dividends they produce and the two companies I’m invested in (Milton and AFIC) have goals that align with my own (to grow their income over time).

It’s just that A200/VAS are so incredibly similar but have the key difference in utilizing a trust structure and not a company. The legislation risk has tipped the scales in favour of ETFs for me moving forward.

This is purely a tax minimisation decision. It has nothing to do with changing the overarching investment principles (investing in great companies) or a shift away from Aussie dividends.

The FI Explorer wrote a great piece on a sceptical view of LICs which some of you out there have emailed me about. I agree with what is written in that article, always have. I never invested in LICs expecting a superior return. What I go back to is the mental aspect of investing. A lot of people who retiree will feel more comfortable living on a relatively stable smooth flow of dividends vs more volatility but a slightly higher return.

 

Strategy 2.5

Okie Dokie.

So here she is. The new…ish strategy moving forward.

It’s called 2.5 because it’s extremely similar to strategy 2 just with a few tweaks. It’s almost like we’re going back to strategy 2 and I didn’t think enough has changed to honour it with strategy 4.

Change 1

Firstly, with the addition of buying more international shares back in the plan, we will move back to a ‘split’ approach.

Our splits have changed slightly from strategy 2 with more of an emphasis on Aussie shares as the dividends are still attractive regardless of franking credits refunds.

We will be looking to maintain a split of

60% A200/VAS/LICs (Aussie)

20% IVV/VTS (US)

20% VEU (world ex US)

We’ll keep our two LICs in the portfolio but won’t buy any more units moving forward.

The plan when buying new shares is a lot easier than looking at when LICs are trading at a premium or not.

Before we buy each month, we will look at the current splits in the portfolio and purchase the shares which have the lowest targeted weighting.

For example, this is what our portfolio currently looks like.

So next time we buy, it will be to ‘top-up’ the lowest split, which in this case will be World ex US or VEU. The splits are all out of wack because we focussed on Aussie equities during the last 12 months. Ideally, you want to be as close to your splits as much as possible. When your portfolio reaches a certain point however, the market movements will be so great that you might find it hard to maintain your splits even by buying the lowest weighting split. But this will be a good problem to have since your portfolio at that stage will be in the 7 figures.

Something really cool about this strategy is that you’re always buying the split that is down. If one split booms but the others don’t, you won’t be purchasing more of that booming split.

Change 2

The second change we will be making is switching from VTS to IVV.

iShares Core S&P 500 ETF is extremely similar to VTS with a few differences but no major ones we’re concerned about. VTS is more diversified and 0.01% cheaper but is not domiciled in Australia and does not offer DRP. This means that we need to fill in the W-8BEN-E form every three years or so.

The W-8BEN-E form is literally 10 minutes of your time every 3 years and is often overblown in terms of effort, but nonetheless, the two funds are so similar that it’s worth saving the extra admin plus having the DRP option available which I’ve been looking to use as of late.

Here are their 10-year returns to just show how similar they are.

Change 3

The third part of the plan is a hybrid approach between relying only on dividends vs dividends and selling parts of the portfolio. IVV and VEU don’t pay a lot of dividends, but they still pay them.

IVV has returned 3.27% over the last decade and VEU has done 2.85%. Not great, but still cash flowing into the account. And more importantly, those dividends are unfranked income!

We will aim to not touch the portfolio and use the dividends from both Aussie and international shares to live on. If it’s a bad year, however, we will look to sell-off some units to cover the shortfall.

I’ve already gone into why selling parts of the portfolio is perfectly ok if you allow for it to recover in strategy 2. In fact, from a rational market point of view, there’s really little difference between selling units for income and having the company pay you via a dividend. In theory, both should have the exact same consequences. But markets are not rational so they vary to some degree and is a prime reason why we like the dividend approach more.

How It Works

Let’s look at how the newly allocated portfolio would have done during the last 12 months. Here, I have created a dummy portfolio with all trades done exactly one year ago with the total of the portfolio’s value being a cool $1M which is what we’re aiming for.

Aussie equities (I had to use VAS to go back far enough) @ 60%
US (IVV) @ 20%
World ex US (VEU) @ 20%

$46,809 worth of dividends ain’t bad and is more than of FI number of ~$42K!

Bumping up the weighting of Aussie shares to 60% (it was 40% for strategy 2), plus the lower dividend payments of our international shares have actually generated enough income for us to live off during the last 12 months.

But this was a particularly good year for Aussie shares and it won’t be this good all the time. We will save any extra income during those good years to create a cash buffer in preparation for the bad ones that will no doubt come.

If it’s a particularly bad year for dividends, we will look at selling off some units to cover our expenses.

The other thing is that the likelihood of us not earning any money in retirement is extremely low. I’ve covered this in what retire early means to us in the context of FIRE.

I’m extremely confident that the dividends from a $1M portfolio that is weighted to 60% Aussie shares plus any additional income will be more than enough for us.

Selling off units is there as an option but I don’t think we’ll need it tbh!

Time will tell.

To summarise strategy 2.5

  1. An internationally diversified portfolio consisting of 60% Aussie shares and 40% international
  2. Buying IVV instead of VTS moving forward for DRP and Australian domiciled.
  3. Buying Aussie ETFs and not LICs due to risks associated with franking credits. ETFs don’t pay fully franked dividends and are impacted slightly less in the event of legislation passing.

 

 

Stop Changing Strategies Dude!

This is you

“Man, you flip flop more than my thongs! Stick to one strategy mate and stay the course. If the axing of the franking credit refund caused you to change strategies, you were never in it for the right reasons.”

And this is me

“Yo! The overarching strategy of investing in great companies has never changed. There was definitely a major difference between strategy 1 and strategy 2. But the fundamentals from strategy 2 to 3 and now to 2.5 are exactly the same”

The thing is, investing in great companies should always be the number 1 goal. All this other shit comes later.

The issue with picking the good companies from the duds is that it’s really hard to do. Which is why index investing is so cool.

The tweaks between our strategies are really fine-tuning our portfolio to meet our specific needs in the following areas:

  1. Mindset/sleep at night factor
  2. Simplicity
  3. Tax minimisation
  4. Mitigating legislation risk (something I hadn’t considered before)

I think everyone should be a bit flexible with how they invest to a certain degree. Picking one strategy and literally not changing anything during your whole life seems unlikely. Franking credit refunds are a great example of this.

And what’s to say the government won’t impose some stupid tax on other asset classes or something else within our life?

It would be ridiculous to suggest that if the government turned around and started taxing Aussie shares an additional 30% that everyone should just ‘stay the course’ and not look at alternative methods.

Everyone has their tipping point when enough is enough. And even though the refund remains, for now, I’m looking at protecting against this potential rule change without drastically upheaving everything.

I think strategy 2.5 is a nice balance between everything that’s important to us in an investing strategy.

 

Conclusion

I’m still learning as I go.

Judging by some of the emails I get, you’d think that I’m some sort of investing guru which couldn’t be further from the truth.

This years election taught me a valuable lesson that I hadn’t considered as much as I should have before.

The legislation risks for investing in general but particularly the very real possibility of no more franking credit refunds one day.

For us and I assume a lot of people chasing FIRE, franking credits without the refund in retirement won’t be worth the concentration risk or the ~4% yield (still pretty good) when you consider that you’re losing up to 30% of your return due to the additional tax that you otherwise wouldn’t be paying had you invested in something other than franked dividends.

Although not completely, Strategy 2.5 mitigates this potential change by re-introducing international shares back in the portfolio which reduces our reliance on Aussie dividends. It also makes other small changes as mentioned above.

When we made the shift away from property to focus on shares, the number 1 goal was to invest in great companies. None of this other stuff is as important as that. Index investing means we don’t have to research which companies are going to be good or bad. It filters that stuff out for us.

Because we don’t have to worry about choosing the good companies from the bad, we can instead spend our time to tweak our strategies so they align with what’s most important to us.

Mrs FB and I optimise the portfolio to improve these areas:

  1. Mindset/sleep at night factor
  2. Simplicity
  3. Tax minimisation
  4. Mitigating legislation risk (new)

Strategy 2.5 improves on all of these areas whilst not uprooting our investing fundamentals which is what any good tweak should do!

That’s it for now.

Let me know what you think in the comment section below šŸ¤™

 

Spark that šŸ”„

ETFs vs LICs and Strategy 3 Revisited

ETFs vs LICs and Strategy 3 Revisited

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-tradedĀ 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 likeĀ 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 wrote about the benefits of index investing brieflyĀ in ‘Our Investing Strategy Explained‘ post.

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.

Let’s begin.

 

Listed Investment Companies

GuideToLICs2

FYI when I refer to LICs, I’m referring to the older ‘granddaddy‘ LICs like AFI, ARGO, Milton etc.Ā 

 

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.

Sound familiar?

It should because, in a nutshell, ETFs are essentially doing the same thing. But there are key differences.

 

 

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.

Same but different

 

Management Fees

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: GenerallyĀ ETFs

 

Legal Structure/NAV

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

Closed-Ended

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.

Fake LIC

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.

 

Open-Ended

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 shareholderĀ 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?Ā 

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.Ā 

 

Investment Style

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.Ā 

 

Retained Earnings

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.

ETF Income flow

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.

LIC Income flow

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?Ā 

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.Ā 

 

DSSP/BSP

Without going into too much detail, Dividend Substitution Share Plan (DSSP) andĀ 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.

If you want to read more about it, check out fellow FIRE bloggerĀ Carpe Dividendum’s excellent article.

WINNER: LICs

Fully Franked Dividends

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.

LIC Franking

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?

ETF franking

 

The end result for the investor is exactly the same. A grossed-up dividend ofĀ $59.22 after tax.

WINNER: Franking does not matter when comparing LICs to ETFs.

 

In a nutshell, the key differences are:

Type Management Fees (MER) Investment Style Legal Structure Net Asset Value (NAV) DSSP
ETF As low as 0.04% Passive. Usually tracks an index and does not seek to outperform. Trust Trades on, or very close to NAV No
LIC Although slightly higher for an equivalentĀ ETF, the old LICs generally are all under around 0.18%. Active. Seeks to outperform an index over the long term. Company Can trade at a discount or premium to the NAV of the fund. Yes

 

So Which One’s Better?

HomerThinking

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, andĀ 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.

 

Conclusion

Peter loves Homer

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…

 

Strategy 3?

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 yieldingĀ Aussie shares in the form of ETFs and LICs.

We currently have nearly $100K in international securitiesĀ 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 wrote a little bit more about my reasoning to move to strategy 3 in our September 2018 Net Worth Update.

 

Historic Returns

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.

LICs VAS Returns Historic

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 divulgeĀ 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 aĀ Dividend Substitution Share Plan.

So what am I buying and how am I deciding what to purchase?Ā 

ETF

A200
MER: 0.07%
Benchmark: Solactive Australia 200 Index

Why itā€™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.

A200vsA300

Source: https://au.spindices.com/indices/equity/sp-asx-300

I’m choosing the ETF with the lower management fee every day of the week.

 

LICs

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.

Full SMA review if you’re interested.

When To Buy?

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 essentiallyĀ 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:

  1. 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)
  2. Invest in whichever LIC is trading at the biggest discount
  3. 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 headĀ šŸ˜ˆ

 

UPDATE: We have officially moved to Strategy 2.5 in Sept 2019

Vanguard Diversified Index ETFs

Vanguard Diversified Index ETFs

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

One ETF to rule them all?

OneETF

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

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

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

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

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

 

Vanguard Diversified ETFs

 

Vanguard Diversified ETFs

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

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

They solve a few problems that our three options above had

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

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

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

VCMM

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

Who Is This Suited For?

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

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

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

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

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

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

 

Why I Won’t Be Switching To These ETFs

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

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

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

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

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

combo1

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

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

combo2

Holy shit!

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

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

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

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

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

 

Conclusion

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

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

Australian Financial Independence Calculator

Australian Financial Independence Calculator

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

 

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

 

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

 

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

 

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

 

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

 

Decisions decisions decisions!

 

 

IntroducingĀ TheĀ Australian Financial Independence Calculator

 

 

Australian Financial Independence Calculator_2Australian Financial Independence Calculator

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

 

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

 

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

 

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

 

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

 

Australian Financial Independence Calculator_3

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

 

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

 

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

 

Pretty cool huh!

 

 

Video Of The Calculator In Action

 

Work In ProgressĀ 

 

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

Download Now

 

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

 

Australian FIRE Calculator
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