Aussie Firebug

Financial Independence Retire Early

Podcast – Peter Thornhill

Podcast – Peter Thornhill

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Summary

Huge Pod to start 2019!

I have the man, the myth, the legend, Peter Thornhill himself. Author of bestseller Motivated Money, Peter is famous in the FIRE community for his teachings on dividend investing and why it’s the best strategy for Australians to retire comfortably. And for someone who is currently receiving over $400K a year in passive income via dividends… when he talks, we should listen!

In today’s episode we chat about:

– Peter’s background in investing
– ETFs vs LICs
– How Peter invests
– Capital gains vs Dividends
– International diversification
– Labor removing the franking credit refund
– Why Peter uses a financial advisor
– Debt recycling

and much more

 

Show Notes

Podcast – Portfolio Reporting – Sharesight

Podcast – Portfolio Reporting – Sharesight

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Summary

What do you use to track your portfolio’s true performance?

Does your reporting software take into consideration things like franking credits? DRP? Share splits over time? What about currency movements?

I have tried countless reporting tools and for Aussies, there is none better than Sharesight. And the best thing about it is that it’s free if you have under 10 holdings.

Today I have the pleasure of speaking to Doug Morris, the CEO of Sharesight, the best share portfolio tracker for Aussie investors.

But Sharesight does a lot more than simply telling you the true performance of your portfolio. There’s a bunch of other useful tools and features available and some of which we are going to cover today.

In today’s episode we chat about:
– How Sharesight can help show your true performance
– Tax reports to making lodging your tax return a breeze
– Historic data to quickly see how a theoretical portfolio would have performed in the previous decade or two

and much more

 

Show Notes

 

Transcript:

 

Aussie Firebug: Hey guys, welcome back to another episode of the Aussie Firebug podcast – the Financial Independence podcast for Australians where I interview clever people who have already reached, or are on their way to, Financial Independence and occasionally different products and businesses that I believe can help you reach FIRE sooner!

What do you guys use to track the performance of your portfolio? Do you actually use anything at all? Do you even track the performance of your portfolio?

Today I’m chatting to Doug from Sharesight, which is by far the best portfolio tracking software out there. It’s an Australian, actually I think it’s’ a New Zealand, company but like most things we will claim them as Australian. It’s a company, anyway, that does performance tracking of your portfolio and it’s really a must, especially come tax time. It also takes into consideration things like franking credits, things like DRP, share splits over time, currency movements. I believe that every person that invests in Aussie shares should have an account with Sharesight because one of the best things about it, is that it is free for under 10 holdings. And if you have more than 10 holdings, stay tuned for the end of the pod to see how you can get a discount. I’ve got something special  for you guys at the end.

Basically, we are going to chat to Doug today and what it can offer investors and how I use it as well. I think it is really crucial come tax time because it makes tax insanely easy and we are going to go into it in the pod, but it really, really is a must have for tax time unless you want to go through it yourself and generate it all. It’s really exciting and there are a whole bunch of features as well, that we are going to talk about in the pod, so stay tuned and we are going to get into it now. Cheers.

Aussie Firebug: Welcome back guys to another episode of the Aussie Firebug podcast. Today I have the pleasure of speaking to Doug Morris, the CEO of ShareSight – the best share portfolio tracker for Aussie investors. But Sharesight does a lot more than just telling you the true performance of your portfolio. There’s a bunch of other useful tools and features available and some of which we are going to cover today. Welcome to the podcast Doug!

Doug Morris: Thank you very much Matt for having me on. I appreciate it.

Aussie Firebug: No worries. Now why don’t we begin with: For those that have never used Sharesight, can you give us a brief description of exactly what Sharesight is and how it can help Aussie investors?

Doug Morris: Sure, so Sharesight is fundamentally a portfolio tracking tool It is cloud based software and we focus on performance reporting but we do so at a really accurate level and as a result of that we can product tax reports for investors as well. So we don’t offer anything like execution, or financial advice or stock recommendations, we just stay very focussed on the administration and the tracking of investment portfolios.

Aussie Firebug: Awesome. When was Sharesight first created mate?

Doug Morris: Yea, we are sort of an old startup. We’ve kind of been around since before the entire FinTech movement took off, so we launched in 2008 actually. We were started by a father and son team over in Wellington, New Zealand. So the father, Tony, was a pretty keen investor – a former accountant. And his son was involved in the tech space, not really an engineer himself, but knew enough about it to be dangerous. So Tony, the father, was basically saying, look I need a way to track my performance. And what he was doing, like many of our clients did before they found us, he was doing it in a spreadsheet. He was going in and updating share prices manually, he was trying to combine things like dividends and corporate actions and build some fairly elaborate macros and formulas to work out annualised performance. He just couldn’t figure out for the life of him, why there was no software out there that did this? Because you don’t get this information from your online broker and he just really wanted a way to kind of distill his investment performance in terms of annualised money rate of returns so it can be practical and sort of transferable to other areas of his financial life. So that is really kind of the kernel of how we got started. The guys then built out a Kiwi version with the local nuances there. But always with the view of going over to Australia, just given the size of the DIY market here and some of the inner complexities of things like franking credits and capital gains tax here in Australia. The rest is kind of history.

Aussie Firebug: Interesting, it’s funny that you mention that. I didn’t know it was created in New Zealand. A couple of things I want to touch on, I’m detecting an American accent from your voice so I’d like to get into how you got involved with Sharesight but before we do I’m not too sure if you are aware but Australia has a history of claiming things from New Zealand as our own, a lot of sporting players and I actually think even Phar Lap is a New Zealand horse and we claim it as ours.

Doug Morris: And of course, the Pavlova debate as well.

Aussie Firebug: Well there you go, I’ve always thought Sharesight was Australian. So I’m sure there are some New Zealand listeners that will now have a bit more ammo in regards to that argument online and at the pubs and what now. So going back, 2008 was an interesting year to launch such a software, considering what happened.

Doug Morris: Yea I know it’s funny, the guys only now reflect on the fact that they were launching a DIY investment software into the teeth of the financial crisis, but I think for markets like New Zealand and Australia, they were certainly affected, but not at the scale of things in the States or Europe. The guys, at that time it was just the 2 of them working away at this thing. These kind of tools should be performance-agnostic – what I meant by that is if the market is tanking or the market is on a really long bull run (which we are seeing both of recently) people should stay on top of their performance but obviously human psychology doesn’t always dictate that.

Aussie Firebug: Absolutely, absolutely. And it is so important, you touched on the true performance because that is  very critical when determining how well your investments did. Because I know if you talk to 10 different investors they might have…before such such software as Sharesight, maybe not in 2018, but previously and I’m sure the founders of Sharesight can attest to this as well, a lot of people were missing a few things with their returns and calculations. I know a common one, and I see it to this day in articles and things, they might not factor in Franking Credits or something like that. They miss out on the overall true return of investments which is just so important. I remember when I was Googling, before I found Sharesight which I use and I think is the best, for tracking your shares, there just isn’t a whole bunch that does the true reporting especially specific to Australian circumstances. It definitely has filled the need. It sort of took me by surprise when I was doing some research for this podcast, really, was there no other software on the market, back in 2008, that was doing this?

Doug Morris: Yea it is true. So where you’ll find annualised money-weighted calculation methodology really done appropriately at the cost base level, factoring in dividends and corporate actions and all the rest, you’ll find that in institutional realms. So if you’re a fund manager or a quant or something like that, you’ll have access to some of those tools. But of course, those are big software systems that are totally prohibitive, cost-wise, to the average self-directed investor. And even at my previous career at MorningStar, where I spent 8 or 9 years, they had portfolio watchlist tools but they didn’t really capture true performance. And it is so important, because what I hear a lot when I’m at the pub, sorting casually just saying what I do or talking to investors at various events, I say “How do you track your portfolio”, that’s my leading question and often people will say, I just rely on my broker. Which I just cringe, because that is not an accurate representation of your portfolio because in most cases, your broker doesn’t factor in how long you have held the investment, they don’t factor in dividends either. If you look and say I bought these shares 5 years ago and you are up 200%, that might look really good but when you annualise it, it actually comes down quite a bit. You see it in the press all the time, especially with property, a celebrity bought a 10 million dollar property and sold it for 20, doubling their return. Yea but, they owned it for 12 years and they spent 6 million dollars fixing the place up – these are all the things you need to factor in to investing as well. When you break it down into annualised terms it is transferable to other parts of your life. You get paid in salary,m you pay school fees, you pay a mortgage, you think of interest rates. They are annualised and it shouldn’t be any different in your share portfolio.

Aussie Firebug: Absolutely, it is so important, you read articles about performance of asset classes, and property is a popular one, but usually there is a bias on most articles or they are trying to push some sort of agenda or they are working for some different company, so of course they are going to leave out certain things. And I have even seen it the other way, anti-property people will look at a return from a property but they won’t factor in leverage and the actual how much money cash on cash return, they will just look at the overall return of the property and say that shares outperform but if you actually look it cash on cash you get a different story. So it goes both ways, it’s not just one asset class.

Doug Morris: People misquote stock market indices all the time as well. You hear all the time, the NASDAQ is up 38% on the year. Yea great, but how are you, the investor, investing in the NASDAQ. Are you buying an ETF, are you buying some shares in the market? When you kind of break it down, are you actually going to execute on that. That’s where tracking becomes so important.

Aussie Firebug: Yes, absolutely. Now I wanted to ask before we got off on a tangent, how does a, I’m guessing you are from the States with that accent?

Doug Morris: That’s right, yes.

Aussie Firebug: How does a yank come across to Australia and get involved with a company like Sharesight?

Doug Morris: I’ve been in Sydney for about 10 years and I originally came down with MorningStar. I got my first job out of uni with them, working in their asset allocation research division and I wanted to move more into the client-facing and sales and product realm. And they launched a program where they trained us up and sent out to various international offices. I was given the choice of Toronto or Sydney, and being from Chicago I said I’m not going to move to Toronto, it’s even colder and it’s close so send me down to Sydney. It was supposed to be a 1 or 2 year stint and I ended up falling in love with the place and staying. So I worked here for a  number of years with MorningStar. Then a former colleague of mine who invested in Sharesight and was a power user himself came along and asked me if I wanted to join the team. From there I sort of worked away and became CEO after a couple of years. The basis of my interest in Sharesight though was always in the product area in MorningStar where I worked on software products for self-directed investors and financial advisors. I always thought that there was a lot of opportunity out there in terms of helping people look at their real data with these software tools and empowering them to make better investment decisions, really.

Aussie Firebug: Excellent, excellent. Now I guess it sort of depends what weather you prefer but yea, Toronto… I have been to Toronto before, sub 15 with wind chill versus the hot beaches of Sydney, eh might have been an easy decision for you. Although Toronto has the Raptors and the NBA so I do like that.

Doug Morris: They do. No, Toronto is a good city. Nothing against Toronto

Aussie Firebug: And do you know I’m actually from Victoria and they say Melbourne and Toronto are very similar so and I always have liked Melbourne. Yea, Toronto, I’ve got family there it’s really a nice city but the cold, man! It’s freezing when I went and I only went  in the winter and it’s bloody cold although I do snowboard. Although there aren’t really mountains near Toronto, you gotta go west to get to the snow but yes, it’s a good city. Moving on, I wanted to talk about. We know that Sharesight has awesome, kick-ass reporting, true performance of your portfolio, but the other thing I use it personally for is for tax and tax work. It makes tax work an absolute breeze. Now recently, you made some changes to the way that Sharesight does the tax admin work for ETFs especially. And from what I’ve read, I haven’t used it yet, it makes it a breeze for Aussies to do their tax returns, can you go a little bit into these changes and why Sharesight makes tax returns super easy for Aussie investors?

Doug Morris: Sure, so because the way Sharesight works is we actually get the cost basis for all of your investments, we go down pretty deep in terms of the data in terms of the data that we require to get your portfolio set up and running and as a spin out of that we offer our clients, capital gains tax reporting, unrealised capital gains tax reporting and also, taxable income (i.e, dividend income) reporting as well. Our aim with these reports is to give you a really good steer on what your actual tax liabilities are, without going as far as having a seamless way to lodge those taxes. What kind of happens/the way this kind of develops is that it was always, i’m not going to say easy, but more straight forward to calculate tax, be it movements in capital or taxable income, on listed shares. So you bought or sold shares in a company, you receive some dividends – yes, there are some complexities around the franking credits but once we built for all that, it kind of took care of itself. There’s always a few nuances here and there with various corporate actions but those tend to be kind of a manual, off-market sort of transaction anyway so we can help our client base as they popped up. But then what we saw happening was the rise of ETFs. This wasn’t a surprise based on how popular ETFs, and similar vehicles, have become overseas. For example, when I actually interviewed with MorningStar which is all the way back in 2002, I was interviewing for an internship at the time. A piece of advice that I received was Do your research on ETFs and I didn’t even know what an ETF was. At that time they were in the realm of institutional investors, they were using ETFs to park some cash or to hedge, institutional strategies but as we know  ETFS have become mainstream because their low cost, liquid and now-a-days there is an ETF for everything; active ETFs, passive ETFs, there’s really esoteric things out there like crypto ETFs.

Aussie Firebug: I was just about to say, is there a Bitcoin ETF? I didn’t think there was yet.

Doug Morris: There are, it depends what country and I’ve seen a lot of stuff in the press about how they kind of get close and the regulator will knock them back. I would exercise extreme caution when it comes to those, and definitely do you due diligence.

Aussie Firebug: Yea, I just don’t understand. I guess it would be easier for most people, I don’t know why you wouldn’t just buy the Bitcoin yourself? Why you would have to go through and ETF?

Doug Morris: That’s right. You always are going to need a way out of buying the underlying asset itself, and if you can versus buying a sort of packaged investment around it. Just to give you an example of popularity, we offer a Self Managed Superannuation function inside of Sharesight so you can apply that tax setting to your account. And we looked at the data recently and I think it was back in 2008 if you looked at the trade inside of SMSF portfolios, ETFs only accounted for 2% of those buy and sell trades, in those portfolios. Fast forward 10 years, I think the number is 22% of trades inside of SMSF portfolios are ETFs. Which is just a huge increase and if you assume that people are buying and holding ETFs, they aren’t trading them, certainly not on a day trading basis AND if you think of your average SMSF trustee you are going to be doing a lot of buying and holding. I suppose from a lion share in a portfolio, those ETFs are making up more and more of the overall dollar composition of those portfolios.

And so we started to get feedback from our clients, via Twitter and our client forums and from various places, that our tax reporting just wasn’t quite rich enough for ETFs specifically. So we said alright, this is something that we have heard before we’ll just go back to our data providers and huddle internally and figure out if we can do something about this. The problem really turned out to be a lot more complex than we anticipated and we were actually given a lot of help in this regard via our partners at Six Park, who are a robo advisor that uses Sharesight as a platform, so we sort of teamed up on this one. What we did is we went door knocking, we knocked down the door of the ASX, we knocked on the doors of various share registries, we went to the actual ETF providers themselves such as Vanguard and it was just really difficult to get a straight answer on the components of these distributions.

And before I get too far into the weeds and this is kind of the ways it worked, if you buy and hold ETFs you receive distributions. You receive 2 a year or 4 a year depending on when you receive those payouts. Each distribution is actually comprised of hundreds, if not thousands, of dividends and other payments from all the underlying companies in the ETF. And a lot of those ETFs are investing locally, but some of them are investing overseas as well and some are investing in other asset classes like fixed interest, cash, bonds and all that. And you are left with this this sort of mess of a distribution every time you get paid, and that’s all well and good over the course of the year because Sharesight was displaying the gross and the net dividend. But then what happens at the end of the financial year is you get a tax report, an annual statement, from the registry. And if you’ve seen one of these, from say Computershare, you’ll know how complex they have become, especially since the ATO has now rolled out a new taxation treatment to these things called AMIT, which is just another layer of complexity that I won’t get into right now. But basically, and you’ll have dozens of components in there that you’ve been paid over the course of the financial year. So our client base is basically coming back to us and sayings, look, I’ve got all these dividends, how are these selected in Sharesight? So this is what took us on the hunt for this data and what we ended up doing was, Computershare came to the table and they were able to deliver us accurate breakdowns of these ETF distributions throughout the course of the year, so we plug those into Sharesight, retrospectively. But for the ETFs that we were not able to get data for, we built kind of a pro-rata tool so that you can actually take your statement and can whack in the end of year figures and Sharesight will automatically cascade those back in time, to give you accurate breakdowns.

I think the crux of this problem is that investment trusts, like managed funds, they were really designed to be like here, take my money and then send me a report at the end of the year because I’m going to trust you with my funds and you do your thing  and just post me a statement. But ETFs, from a technical standpoint, are trusts, people like you and me are buying them and selling them all the time and are using tools like Sharesight and so their expectation is that they have this always on mentality where they want to know performance and dividends in real time. They are looking at our mobile app and are logging in a few times a week and relying on a paper statement at the end of the year, just isn’t good enough for the plugged in investor who is using ETFs in their portfolio. So at the end of the day, we were really able to make a huge improvement to the accuracy of our ETF distribution tax reports and based on the feedback we have received we have hit the mark but to be totally honest, we still don’t know what the correct answer or way to do this and there is really no guidance from anyone out there on this So we feel like we may be setting a bit of a standard for the industry so it has been really interesting, and I would say, nerdy, but we are proud of the work that we have done and the investors seem to  be pretty happy with it so far.

Aussie Firebug: So I’ve got a question about that because last year, I had a relatively complicated tax return just with a few things, because I invest through a trust myself and I went through an accountant because I have an accountant, and my goal eventually, when I reach FI and I move into the retirement phase, is to sell my properties off and just be 100% passive income via ETFs and LICs. When I’m at that stage, I plan to do my tax returns myself which is where a tool like Sharesight really comes in handy, but my question was, last year I used a combination; I had reports from Sharesight that I forwarded to my accountant but I also used the Vanguard reports that you talk about, that distributed a few months after the end of the financial year. Are you saying that you have access to that data once it is released from Vanguard, you know exactly what it is or the investor still needs to have that tax report from Vanguard and plug it into Sharesight to make it 100% correct? Can you just clarify that part?

Doug Morris: Sure, it’s a great question. Where we are up to at the moment, the Vanguards of the world or the Aus Shares or the Beta Shares, the providers themselves (the fund managers, if you will) they only do this exercise of the tax reporting/dividend reporting at the end of the year. So as we get that we will backfill that information inside your share portfolio

Aussie Firebug: So that’s automatic, you guys know about that?

Doug Morris: Yes, that’s right. So we know about that at the end of the financial year, we won’t know about that though for each dividend that has been paid throughout the year, if that makes sense. We are only as good as the data that we can get from the provider themselves and if you think about how complex this must be for Vanguard, right? You’ve got millions of investors in these really complex structures, they must have, quite frankly, some hellish process to go through and figure what you (individual investor) are actually liable for, on a distribution basis. Because what we’ve actually seen, is that, even if I hold, say, VAS (Vanguard Australian Shares) and you own VAS as well, and we’ve owned it for a similar time period if we have remarkably different balances in that particular ETF, our payouts might be different because of the way that the cash is actually distributed to investors via the registry. So, that’s actually quite interesting, it’s a big end of year process and what you’ll find in Sharesight is that around hopefully September (although this particular year, since it was our first go at this it was October) you will being to see the breakdowns added to your portfolio automatically.

Aussie Firebug: Ok, so October/November. Will Sharesight users be notified of that or will you just see it in the tax reporting report?

Doug Morris: Indeed. So what we will do is in the platform itself, we have a messaging capability. We will push a message saying, hey we’ve updated the end of year tax details for you.

Aussie Firebug: Great, awesome. That’s very good to know. If you are concerned about your tax liability throughout the year, it might not be 100% accurate (that’s sort of what I am getting) but at the end of the financial year, come October/November it should be all good for the previous financial year once you have received those reports and put them into the system.

Doug Morris: That’s right. So throughout the year it will be accurate or very close to being accurate for performance reasons which is kind of the most important things as you go. But then come tax time, there is a bit of a catch-up period and then we backfill the tax information.

Aussie Firebug: Awesome, for me, I like to lodge my personal tax return as soon as possible and for those people that do invest in shares in their own name, it might be annoying to wait a few months but I have no issues with waiting a few months and having the reports come out and then just having one place where I can either generate the report and send it to my accountant or I can generate the report and fill in my tax return myself. It’s all my investments all in one report and I’ve seen a few articles as well that you’ve posted, which I will link in the show notes, about the step by step where abouts in your tax return in the ATO form, where you fill out and what data you need to enter here and there. It’s really good. Is there any work to integrate directly? Like if you are doing a tax return yourself, can you integrate directly to myGov, or anything like that, is there anything like that in the works?

Doug Morris: We haven’t actually progressed that in any kind of seriousness, we’ve definitely talked about how cool it would be. Because at the moment, what we find that most of our clients do, they file themselves using our reports and in fact, even on our taxable income report now, you’ll see the alpha-numeric codes that you need when you are filing the tax that you know this is field 10A and this is your total for that, so we make it really easy, honestly kind of a two tab solution. But the alternative to that, is that if you are working with an accountant, and they are using Xero, who we have a linkage with, they they can be filed straight through there so that is the alternative but unfortunately, no direct sync from Sharesight at this time. Which is also a function of the fact that we are operating in several global markets, and so, prioritising one tax integration verse another is tough stuff.

Aussie Firebug: Nah, that would be next level. Yes, as I said I will link the article in the show notes, and it is very straight forward. It shows you exactly where you need to go to when you are launching your return and what data needs to go in where…it is really cool.  So we know Sharesight has awesome performance and awesome reporting and tax reporting which are the two main purposes that I use it for. Are there any other awesome features that I am missing out on that I don’t know about?

Doug Morris: Yea, it is a pretty deep product. I mean, the nice thing about Sharesight is that it is simple enough for your beginner investor to use, but it is complex enough for your sophisticated investor as well. So I put myself in the middle of those two spectrums. What I use personally quite a bit is custom groups. Custom Groups is a lesser known feature in Sharesight. What it allows you to do is build your own kind of worldview of your investments and so throughout the product you can choose to group by market, or country, or sector or industry, which is all kind of stock standard stuff. But Custom Groups allows you to come up with your own classification system and then literally drag and drop the companies or ETFs or whatever you own into those classifications. And so my worldview as an American living in Australia, takes a core satellite approach, who favours tax; who likes ETFs; there is really no standard asset allocation that works for me, so I build my own. I have, like I said, a core satellite approach where I have my blue chip tech stocks that I know I am not going to sell, I have a few more speculative tech stocks that I want to keep a closer eye on. I’ve got some retirement savings in The States and I’m in some Super here so it allows me to customise exactly how I look at the world and then therefore I can apply that to other parts of the product. So, obviously, you want to look at how you are performing in each one of those customised groups and you can look at your exposuress as well. You can apply the Custom Groups feature to reports, like the Diversity report, which shows you how your exposures change over time based on how you view the world.

Aussie Firebug: Awesome, have you got an article about Custom Groups that I can link to on the site?

Doug Morris: Yes, sure we can find you one.

Aussie Firebug: Awesome, I’ll put that in the show notes then. And I’ll check that out myself because that is something that I am not using which sounds awesome. What’s next for Sharesight? Anything else being cooked up in the kitchen that we can look forward to?

Doug Morris: The product is never done, we are always building out the product. A couple of things that we are focussing on. One is just more broker connections, there are so many online brokers out there and there are a lot of these international brokers moving hard into Australia, as well. They are really low cost brokers, so if you indeed looking to cut down on your fixed cost for investing I would encourage you to take a look at some of these. One that we are working hard to integrate with right now is Interactive Brokers, and they are huge. I mean, they would be bigger at a global scale, they are much bigger than a CommSec even. And they offer access, low cost access, to any asset class you can imagine. If you want to trade US shares, you want to trade European ETFs, they even have support for cryptocurrencies in their platform. That is a really popular broker for hardcore DIY investors so we are looking to integrate with those guys. Which really just means that the flow of trades will be automatic with a Single Sign On. Apart from that, we are brainstorming some ways that we can do a bit more to leverage our user base. We have really grown the user base to a pretty large scale now and building a community of investors is something that would add some real value and some benefit. One idea that we are workshopping is, what if we had something like “Investors like you”. So based on anonymous data, that we could glean from you and your portfolio. What if we could connect you to other investors who had similar investment appetites as yourself, and build a community around that. We are looking to leverage our own scale to provide some value for our client base.

Aussie Firebug: Interesting. Maybe like a social media aspect like a forum or something? I have to say, I didn’t have this as one of my questions but I gotta say it now because I use them – Selfwealth is the broker that I use and the last time I checked, you didn’t have native integration. The way I integrate SelfWealth with you guys, for my trades, is I send an email. I have an automatic rule that when I get the trade through SelfWealth, it sends an email to that special email that you set up in Sharesight and the trades come through semi-automatically. Is there anything in the works to get SelfWealth integrated natively?

Doug Morris: What you’ve described is we support their contract note. If you make a trade, you can set it up to where Sharesight will automatically process your contract note and store it against the trade. But we do not have a facility for automatically importing the historical trade, at this time. The way we make those decisions is if you get on our customer forums and you vote it or you post about it, we definitely look at that for the stuff that we build next. That would be my encouragement to anybody that wants that deeper level of integration with SelfWealth to do that. A stop-gap measure in the meantime is, you can export your trading history from SelfWealth; it will come out as a CSV or an Excel file. You can easily just upload that into Sharesight as well, and it’s really the same process with a couple more clicks, rather than that API.

Aussie Firebug: It’s not a dealbreaker or anything,  but I just had to say it out. I think I’ve tweeted you guys a few times like, “Hurry up with the SelfWealth integration” but I’ll get on the forums, I’ll get the Aussie Firebug community to help out.

Doug Morris: We are pretty democratic about what we build, even in my position as CEO, if I say, “Hey, you know what would be cool to build?”, the developers often come back and say, “Here is the stuff we are already working on and you need to prove the case”.

Aussie Firebug: That makes 100% sense. I work in IT myself so I agree with the developers but I’m just being greedy. Anything else you want to chat about Doug, or anything that we haven’t covered?

Doug Morris: No look I really appreciate the opportunity and again, circling back to ETFs and look, I’m an ETF man myself. And what I love about them is the diversity and the exposure that they offer. Because this world was locked away from aussie investors for a long time and really keen to see where they take our portfolios and it will be interesting to see what happens here, especially with the Share Markets as they are getting a little unsteady at the top.

Aussie Firebug: Absolutely, it’s going to be interesting the next 24 months, but I don’t like to time the market that is not what we do on the race to Financial Independence to Retire Early. Time in the market beats time in the market, so we stay the course but it’s going to be interesting, we’re going to see who can hold their nerve in the next few months maybe but that’s another story. Look Doug, it has been an absolute pleasure chatting to you, thank you so much for coming on the show. Sharesight is a fantastic product, I use it. It’s free for your first 10 holdings and then there’s pricing after that but recommended to anyone. It’s the best reporting tool that I’ve come across by far. So thanks for coming on and chatting today mate.

Doug Morris: Thank you very much mnate, I appreciate the opportunity.

Aussie Firebug: Wow what a podcast, I hope you guys enjoyed it as much as i did creating it. Sharesight really helpful software, really really good performance portfolio. tracking software and the fact that it’s free for 10 holdings or under is just insane i think. The time and efficiency you get generating those reports for tax time is so so good. And a lot of people in the firte community will have 10 and under holdings just because we tend to invest in a few ETFs or LICs and we don’t have an array of holdings. The value that you get from that free plan is just insane. I love that they offer that. For people that have over 10 holdings and would like to sign up with Sharesight which I totally think is worth the money, especially if your having just a starter or an investor plan. I did mention at the start of the pod that i have something special for you guys, and I do. I actually have a special link and if you sign up you get the first 2 months for free. So the link is aussiefirebug.com/sharesight. If you use that link and you’re a new account, or you’re coming from a free account, and you want to move to a starter or investor plan, you will get the first 2 months off the price and you’ll get those first two months for free. That’s only for Aussie Firebug listeners so aussiefirebug.com/sharesight. Check it out, since we’ve recorded the pod I’ve upgraded to the investor plan, so I get a few more features now and I really, really enjoy it. The ability to create the dummy portfolios so I can have as many different portfolios and I can do historical planning, it really helps me write my articles and if I’m ever thinking what would a portfolio of this mix look like, or have looked like or would have performed in the last 20 years and I can seriously just whip it up, and spin it up and have a look at the performance of that portfolio in a matter of minutes. It’s really really powerful and there’s the whole custom grouping things, it really solid software and the tax reporting of it is just next level. Like I said at the start and during the pod for aussie investors that invest in the share market, really a must have, it’s the best reporting software that’s out there and it factors everything in that’s unique to Australia which I really, really like. So check it out, it’s got the free plan but if you need to do the investor plan not the starter you can use my link, and that’s Sharesight. I’ve been using these guys for over a year now and I really, really like them. Now moving on before we wrap up this pod, I of course like every single podcast will read out the iTunes comments that you guys have left me.

I’ve got a few here since I last read these out, but starting on the first one I’ve got… Oh I cannot pronounce this name rat-rat-ratsnatag, I have no idea how to pronounce that, they gave me five stars anyway, and they write: “Thanks Mr. Firebug for the crisp and real life interviews, especially for Aussies, very helpful”. Thank you, the name I cannot pronounce. Thank you for that five stars.

Our next submission, or our next review comes from ‘Fire Fields’ – “Five stars, must listen, i can’t put this down. We are so lucky to have such great local fire content available”. Aw, thank you very much.

Next comment comes from sarafxds, hard names to pronounce this week  – “just one thing, five stars. Just one thing, i love, love, love your podcast but please stop saying ‘aks’ – a k s, your knowledge and passion is fantastic but I can see my grammar teacher wincing everytime you say it”. Ah, do you know what Mrs. Firebug had a chuckle at this one because my grammar is horrible, it always has been. I’m borderline dyslexic, i get pulled up, i get emails nearly every single week about spelling mistakes on the website or in my emails or something, so i will try my best. I feel like i know I’m saying that  incorrectly, and everytime i say it i i think to myself i should edit it out, but I’m just going to try and avoid the word so i’ll just stick to ‘they write in’ or ‘they write’ or something that avoids ‘aks’ which just sounds wrong doesn’t it? Anyway moving on, thank you for the five stars anyway, Sarah .

Our next review comes in from ‘Jjz71’, all these bizarre names this week – “Great podcast, five stars. This podcast should be compulsory for every adult in Australia. Way too many people spend 40 plus hours a week making money for someone else and neglect their own finances”. Oh look, I don’t know if it should be compulsory but I thank  you for your review I do think that finance, in general, should be taught a lot more in school and should be its own subject, that is something I strongly believe in and I hope one day something like that happens, so I guess we’ll just have to wait and see.

The next comment, “5 stars, very well done”, comes from Clarkernucci, “I’m making my way through your podcast, and I think they are really great, full of a lot of really insightful tidbits, such as PocketBook, etc. My only bit of constructive criticism, and you made have already fixed this, would be to invest in a better quality microphone” Thank you for your review and the 5 stars, and I definitely upgraded my microphone and I am getting better at editing the audio quality so I cringe whenever I hear my first episode, or even my first 5 episodes, because the quality is almost unbearable but I’m getting better and I feel like they are better quality these days so just get to the later episodes and they get better, or as you continue to listen they should get better. Thank you for your five stars anyway.

Our next review comes from, Orielton Investor, “5 stars, love your work.Love the podcast Aussie Firebug, looking forward to future learnings and the LIC and ETF journey”. Cheers, thank you very much.

Our last one today, comes from Trent. “Absolute must listen. Hands down one of the best finance podcast. Excellent that it has an Australian perspective on the FIRE movement. Thanks.” Thank you Trent and thank you everyone that puts in a review. It really makes a difference to me when I see a review, I really, really enjoy reading them.Thank you so much for everyone that has put in a review. If you want me to continue to make more, please drop me a comment and a rating on iTunes. Just search for Aussie Firebug on iTunes and you will find me. I’m on all the podcast app and I’m actually on Spotify now – that’s actually big news. I need to update my website but I am on Spotify now so please add me. You can also find me on SoundCloud at soundcloud.com/aussie-firebug. Show notes for this episode can be found on my website, at aussiefirebug.com.

Thanks a lot guys and I will see you next time.

Podcast – Investment Bonds – GenLife

Podcast – Investment Bonds – GenLife

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Summary

Have you ever heard of an investment/insurance bond?

I probably did somewhere along the journey and most likely disregarded them as soon as I heard the word ‘bond’. But don’t be fooled by the name (like I was), there are a lot of advantages that these investments offer and in my opinion, are the best way to invest for children (your own or others).

But it doesn’t stop there. Investment bond can offer a legitimate tax effective alternative to the traditional ETF/LIC route that most Aussies adopt in the pursuit towards FIRE.

There are a few specific rules that need to be followed

In today’s episode, I chat to Catherine Van Deer Veen who is the CEO of Generation Life, an Australian investment and insurance company that’s been around for 15 years currently managing 1.3 Billion dollars for investors.

If you’re thinking about investing for your kids, nieces or nephews or are looking for a tax-efficient alternative investment product, this is the podcast for you!

In this episode, we talk about:

  • What exactly is an Investment Bond
  • What Generation Life can offer to investors
  • The specific rules that you must follow in order to reap the full tax benefits

and much more

 

Show Notes

Investment Property 1 Has Been Sold

Investment Property 1 Has Been Sold

The first of our investment properties (IP) has officially been sold 🎉👏

This is part of our strategy for creating a passive income to fund our lifestyle in retirement. The investment properties had a different purpose in our original strategy for reaching financial independence, but they now will be sold off over the next few years when the time is right.

 

What Was The Return?

I’m so glad I can finally crunch all the numbers for you accurately now it’s been sold because you never quite know how much your true return will be until you actually sell your investment property.

Without a doubt the most interesting question on most peoples minds would be:

‘So how much did you make?’

To cut a long story short, we had an annualized after-tax return of 36.48%. 

If you’re interested in all the finer details of how we arrived at that figure please read on.

 

The Numbers

This IP was built in south-east Melbourne for $340K in 2013. I lived in it originally to receive the FHOG.

Buying expenses

  • $30,000 – Deposit ($9,000 from me plus $21,000 FHOG)
    • I borrowed 91.33% of the property plus LMI. I would not recommend this but that’s what I had and the banks were allowing it back then. I wouldn’t have got that loan in today’s market.
  • $4,634 – LMI even though my parents could have gone guarantor (no hands out for me)

I built this house so there were no expenses for conveyancing or stamp duty. All the loaned money went to the builder who was selling land and house packages.

I had a loan of $319,815 (the LMI got attached to the loan plus some other expenses).

Actual money spent so far: $9,000 

Sweat Equity

  • $3,840 – Landscaping. A new garden for the front, back and sides. Plants, pots, mulch, stones etc.
  • $12,000 – Built a deck. Materials, building permit, labour help costs
  • $1,400 – Concreating
  • $4,410 – Other costs. Materials, Skip bins, money spent on food and other things while renovating etc.

I spent countless weekends with my old man and mum going up to the house to add value to it. This not only saved us money, but I also learnt a bunch of new skills. Win-win.

Total: $22,061

Actual money spent so far: $31,061

Cash Flow/Holding Costs

 

Cash Flow Year 1 Year 2 Year 3 Year 4 Year 5
Rent – All Expenses -$7,590 -$3,929 -$2,744 -$3,047 -$5,841
Depreciation -$8,228 -$8,283 -$7,445 -$6,858 -$6,641
Tax Refund $2,654 $4,519 $3,770 $3,664 $4,618
Total -$4,935 $589 $1,025 $617 -$1,223

 

Total cash flow over the 5 years = -$3,927

Notes:

  • The first year I had to live in the house for 6 months receive the FHOG. This meant that I couldn’t claim all of the expenses for that year. Only for the 6 months I had it as an investment
  • I ended the lease with the tenants and cleaned the house up a bit which is why year 5 is so expensive. I had to cover interest repayments for a few months before the house was sold.
  • Depreciation is not including in the cash flow because it’s not an actual loss of cash flow whereas the tax refund is money coming into my account
  • I used the diminishing value method for depreciation. Don’t ask me why it somehow depreciates more in year 2 than year 1 🤷, that was what was on the report.
  • Tax refunds are based on the 37c tax bracket

Actual money spent so far: $34,986

Selling Costs

  • $700 – Conveyancing (had a friend do it cheap)
  • $2,210 – Used an online agent to sell the property. No way I’m paying 2.5% plus marketing just to list it on RealEstate.com and host a few open days
  • $3,850 – Staging. Maybe unnecessary but I like to think it worked

Total Selling Costs: $6,760

Total money committed to this investment over 5 years: $41,746

The IP was sold last month for $512,500

I invested $41,746 of my own money and received $197,697 in return over a 5 year period.

 

ROI vs ROI On Money Invested

Way too often when anti-property commentators are trying to convince investors that another market has had superior returns over the last X amount of years they usually leave out the most important part of the equation.

Property investors use leverage to buy their investments.

Without factoring in leverage, I don’t understand how anyone can make blanket statements about the true returns of real estate. It’s not comparing apples with apples.

With that said, I want to provide you with both returns numbers so I can further illustrate the point that the only real return number you should be measuring is how much money you put in and how much you get out.

ROI

Capital Gain = (gain from investment – cost of investment) / cost of investment

= ($512,500 – $386,821) / $386,821 = 32.49%

Annualized Capital Gain = 5.79%

 

Gross Yield = Annual Rent / Purchase Price * 100

= $18,720 / $340,000 *100

Gross Rental Yield = 5.51%

 

Net Yield = (Annual Rent – Annual Costs)/ Purchase Price * 100

= $15,985 / $340,000 *100

Net Rental Yield = 4.70%

 

Total Annualized Return

8.28% + 4.70% = 12.98%

Notes:

  • I’m not 100% sure I can simply plus the two return figures together since one is annualized and the other is just an average rent of $360 per week (maths wizards please correct me). But the overall point still stands that the investment doesn’t look great without leverage.
  • The above calculations are assuming that we buy the property outright. This would mean no interest repayments or LMI costs.
  • 12.98% may sound like a decent return, but what’s not factored in is the 100s of hours of labour and travel spent on this property to achieve this result. Considering you could have got better returns from shares over the same time period with no work required, you’d be mad to buy an investment property outright.
  • I have not factored in the replacement costs as the house depreciates. This hidden bill will rear its head eventually. Something shares don’t suffer from.

 

ROI On Money Invested

This one is a lot easier to work out and the true measure of the investment, not an assumption.

ROI = (gain from investment – cost of investment) / cost of investment

= ($197,697 – $41,746) / $41,746 = 373.57%

Annualized Total Return = 36.48%

 

Tax?

In an extremely fortunate turn of events, IP1 became my PPOR after I first moved in to receive the FHOG.

Even though I rented it out, I never bought another house to live in which was not specifically planned but worked out incredibly well. There’s a special rule where you can treat your dwelling as your main residence after you move out for up to six years even if it’s used to produce an income.

Believe it or not, this means that I don’t have to pay a single cent of tax due to the CGT exemption for main residence rule 😱🤑.

 

My Experience With IP1

Investment property 1 taught me more life lessons than any investment in the future ever will.

It was the first house I ever bought, renovated, sacrificed countless weekend adding value to it with my old man helping me out and a whole raft of issues that I had to figure out along the way. From dealing with tenants, discovering how many hoops you have to jump through with banks, lodging insurance claims, rushing to finish the concreting in 38-degree heat (would not recommend), hosting open days and so much more.

Some say property investing can be passive. IP1 was definitely not passive!

It was hard work which did eventually pay off in the long run. Now, how much of its success can I take credit for? That’s a very good question.

Looking back in hindsight I can point out a few key things that happened that I had nothing to do with and was 100% luck

  • FHOG being available boosted my deposit meaning I only had to put down $9K (crazy)
  • The banks lending criteria was completely different back then. No way I get a loan in today’s market only having $9K to put down
  • For the majority of my loan, interest rates were being cut. Every couple of months I had to pay less and less in interest which at the time seemed cool but it’s only with hindsight I can truly understand how fortunate of a time it was to be in real estate. It has only been the last 18 months I have seen my I/O loans rise in rates
  • Melbourne experienced a property boom basically the whole time I had the property. It was only the last 3 months that the prices started to drop and the loans market really tightened their belt. The property was actually under contract before I sold, but it fell through because the buyer couldn’t get finance. I experience this two more time (not officially under contract though) before I had a buyer who was cashed up. Based on what similar properties were selling for, I estimated that IP1 dropped by around $30K since the start of 2018.

I fully admit that all of the above was unforeseen, I was just hoping for the property to keep up with inflation and use leverage to amplify the gains.

One of my favourite quotes of all time comes from the Roman philosopher Seneca.

Seneca

I’m a big believer that you can create your own luck. Whilst I still think that the majority of the return from IP1 came from an uncontrollable event (market boomed), there were things that definitely helped bolster the profits that were in my control.

  • I actually identified the FHOG as an opportunity not to be missed. I signed my contract on the 29th of June which was one day before they scraped the FHOG all together back in 2012. This opportunity was available to all my friends, but most of them did not take it
  • I realised that it was unlikely for me to make a lot of money if I paid for everyone else to do the work for me. I looked to physically add value where I could and since I was full of enthusiasm and energy back then. Countless weekends were spent working on the house. Sacrifices were happily made if that meant I could reach my goal of FIRE quicker
  • I sought advice from experienced property investors who knew what to look for when investing…my parents of course! I understand this luxury isn’t available to every but it’s worth seeking one out if you can. There were small things that helped the investment like buying near public transport, schools, amenities, easy access to the M1, in an area with strong employment options and projects scheduled for the future etc.
  • Getting out of my comfort zone to learn new things such as selling IP1 online saving over $15K in commission fees. The experience I gained from negotiating the deals was invaluable. Some might argue that a skilled and experienced agent could have secured a better sale price. That may be true but we’ll never know. What I do know is that I saved over $15K doing it myself and I’m choosing to save $15K over potentially getting a higher profit every day of the week!

 

Why Did I Sell?

The strategy moving forward is to sell all the investment properties and transition to a more cash flow portfolio of ETFs/LICs. IP1 was the first cab off the rank for the following reasons

  1. The market had gone bananas and I was very keen to lock in that profit and not risk something happening, which sorta happened with the market pullback in the last few months. But I’m very happy with the return we got so no complaints here 🙂
  2. I would have reached 6 years next year which would have affected the main residence status for tax purposes. This means that I would have had to pay taxes on part of the sale
  3. There was some upkeep work that I was fed up with. IP2 and IP3 are part of a body corp which takes care of a lot of the maintenance.
  4. Whilst IP1 had gone up considerably in value, the cash flow was still shithouse! Technically positive cash flow after the tax refund during the last few years (apart from the selling year due to the extra costs). It still was nowhere near as good as what shares could offer for half the investment.

 

Conclusion

Overall IP1 has been a very successful investment in terms of both return and life skills obtained. I was very fortunate to be in the market during the time I was and I’m pretty confident in saying that I’m most likely never going to make as much money in any other investment ever again.

This may sound like a bummer but the truth is that IP1 was a hell of a lot of work! I can’t be effed doing all that again and I doubt I will have as lucky timings with the market twice. It’s a risk I don’t have to take and Strategy 3 suits our current lifestyle better being so passive.

What’s really hard to measure and has not been factored into the above return is all the physical work required. It was essentially a side hustle I did on weekends (not every weekend but a lot). If I deducted the hours worked * an hourly rate, the return would be less.

I’m still a fan of property investing for the right investor, but I am no longer the right investor and will continue with our strategy of selling off the other two IPs when the times right.  It’s my opinion that there are more problems to solve with real estate and more opportunities for those who seek the challenge vs shares.

How has your experience been with real estate? I would love to hear from others positive or negative in the comment section below 👇

 

 

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-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 wrote about the benefits of index investing briefly 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. 

 

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: Generally 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 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. 

 

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. 

 

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? 

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. 

 

DSSP/BSP

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.

If you want to read more about it, check out fellow FIRE blogger 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 of $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 equivalent 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, 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.

 

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 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 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 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? 

ETF

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.

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 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:

  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 head 😈

 

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

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