Its important that in your pursuit of FIRE that you set yourself goals, decide on an investment strategy and then keep yourself accountable to both.
My goal is to reach leanFIRE, start a family and then eventually reach FatFIRE where I can afford buy my own block of land in the country to raise my kids. This means to sustain me forever according to the 4% rule, I need to buy and hold a portfolio of around $600K initially, increasing to around $1M for FatFIRE.
One of the unique tax retirement structures in Australia is superannuation or simply called super. I have a great package with my company that pays an equivalent of 28% super, and I also have to pay the minimum personal mandatory post tax 5% of my wage contribution. At the time of writing I currently have around $300K or so in super, which was boosted because I used to salary sacrifice additional contributions up to my concessional cap of $15,000 per year (under this arrangement you only pay tax at 15% vice the marginal rate of up to 47%). This means even if I quit today, invested in the market and after fees I would still have a guaranteed income of almost $3000 a month for the rest of my life from my preservation age (‘traditional’ or government retirement age).
So whilst I am aggressively frugal, saving and investing for a baseline FIRE, I know that my FIRE portfolio doesn’t need to last me forever – only around 25-30 years until I can access my super nest egg which would then do the heavy lifting. This means although I am basing my FIRE number on the 4% rule, I could actually draw it down at a much higher rate, even over double the 4% rule and it would still safely last me. Market crashes could affect this, but I also have some diversified streams of passive income from my other businesses. If a serious market correction occurred and cutting back on expenses wasn’t enough, I could pick up some part time work to see the bear market out. I am also actively working on developing new income streams.
Working backwards, this means I would only need about $300K of ETFs based on leanFIRE, or about $500K for fatFIRE. Although, 30 years is a long time and I am sure there might be some legislative changes and potentially even a lifting of the preservation age by the time I get there. Based on those unknowns, and the fact that I truly love and am passionate about my job, I am happy to continue flying for a little longer to increase the cushion.
I am still flexible, but currently weighing up whether working full time as a Pilot would be appropriate with a young family, or whether I should convert to a flexible or part time work arrangement. Of course another option is whether I should simply hand back my wings and focus more on my family, recreation and my businesses. Thankfully I still have a few years before I need to cross that bridge, so for now I will continue being as ruthlessly frugal and efficient as possible using my Investment strategy!
Personally, I follow a rock solid and idiot proof investment strategy, which combines the three strategies of Dollar Cost Averaging,Buy the Dip and buy and hold. I call this ‘DCA the Dip and hold’ or DDH. More on this to come!
I aim to keep myself accountable in a few ways, one of which being this website! I have some very close family, mates, business associates and networks and we all try our best to keep ourselves accountable to each other, discussing our earnings, budgets, savings and investments. The FIRE community itself has actually proved to be an awesome way to stay accountable to your goals with your peers.
My Strategy – DCA the Dip and Hold
So into the nuts and bolts of DDH. Its a super simple strategy, where I make a regular investment decision every fortnight on which index funds to purchase and hold. That’s it – Easy as!
At the moment, my goal is to purchase $3K worth of index funds every fortnight; the majority of this comes from my job working as a pilot, but I fill the gap using income from my passive investments (reinvesting dividends from the portfolio) as well as that from some side hustles (such as eBay selling, website and property developments, and T-shirt/sticker sales).
Rather than buying a set amount of shares every fortnight, I allocate a set amount of money. This is a way of automating my investment strategy which also has a few other awesome benefits.
In terms of which index fund I buy, I split my purchases across 9 different index funds. These include Australian, US and international shares., with a focus on Australian shares due to their high dividend yield and franking credits.
Specifically, these 9 are spready across 5 ultra low fee diversified ETFs, and 4 low cost diversified LICs which focus on increasing dividend streams to shareholders. I purchase these all through the Australian Stock Exchange, but if you live in another country you can easily purchase these same or similar products through your exchange. The Vanguard ETF products are all available on global markets as they can be internationally domiciled (different name for the wrapper, same parcel of shares) as well as there may be similar low fee LICs on your exchange.
- Betashares Australian top 200 index fund (ASX:A200) MER = .07%
- Vanguard Australian shares top 300 (ASX:VAS) MER = .10%
- Vanguard Total US Market (ASX:VTS) MER =.04%
- Blackrock iShares S&P 500 ETF Total US market (ASX:IVV) MER = .04%
- Vanguard Total world ex US (VAS:VEU) MER = .09%
- Australian Foundation Investment Company (ASX:AFI) MER = .14%
- Milton investment corporation (ASX:MLT) MER = .12%
- Argo Investments (ASX:ARG) MER = .16%
- Brickworks investments (ASX:BKI) MER = .17%
You might be wondering why the hell I would buy say BKI with its MER of .17% over the VTS with its truly amazing .04%. This is a valid question, and the reason I include some of these LICs is that due to their closed end nature, they have the ability to trade at a net premium or discount to their total net asset value (NAV) sometimes called the net trade able assets (NTA).
These figures are published every month (you only care about the pre-tax NAV or NTA figure) and you can interpolate inter month using the relative performance of the index with some simple maths, or alternatively using Pat the Shufflers LIC discount spreadsheet – seriously awesome work Pat you save me a good half an hour every payday!
This means that although your paying a higher MER, you might be able to snag a discount and buy the LIC at 1 or 2% under its fair value. Lets be realistic here, on $100K invested we are talking about the difference between a yearly fee of $40 in VTS with $170 in BKI – if you managed to buy it at 2% undervalued, you’ve nabbed yourself $2000 in value which is over 15 years worth of paying the higher management fee. And if we are talking about VTS vs MLT, its 25 years worth.
The amount invested and numbers here are arbitrary, but the percentages work for any value trade. Whilst I have used VTS as an example to be conservative, US shares generally speaking are more geared to capital growth vs dividend yield, so a fairer comparison to the Aussie LICs are the Aussie index funds. A 2% purchase discount on MLT compared to A200 equates to 40 years of free management premiums!
So which one do I buy?
The debate between ETFs and LICs and which is better rages on in the FIRE community, but honestly if you choose either you are going to fall pretty close to dead on the mark. Actually getting started, and investing earlier is going to have a much greater influence than the difference between these two factors.
In a nutshell (and probably grossly oversimplifying) ETFs are a relatively straightforward open ended trust structure which must payout all dividends directly to share holders within a financial year (or face hefty penalties), wheras LICs are a closed end corporate structure which can retain earnings for future distribution.
This means that if the stock market is raging and throwing off big cash dividends, your ETF must distribute this higher dividend to you and you might get pinged with some higher income tax, and then in the bear years the ETF might have a reduced dividend payout. The LIC on the other hand can retain earnings and feed it back out to you over time in a much smoother and predicable (and therefore tax efficient) manner, which a lot of retirees prefer.
ETFs automatically rebalance depending on the index, which due to market capital in Australia is fairly heavy on financials and mining stocks. LICs on the other hand employ a fund manager to pick stocks. Whilst I am against stock picking (especially when you have to pay a premium to do so like most actively managed funds) the older low cost conservative LICs have a proven track record. Their portfolios mostly mimic the index with the ability to deviate away from some of the larger speculative sectors and focus more in high dividend yielding sectors.
But its not just the fact that you can buy a LIC for a price below its value that I like. The LICs I own have a strong history of producing increasing dividend streams to shareholders. And ultimately, we are building a Get FIREd portfolio to replace the income we earn as an employee, so we want a dividend stream right? I’ll delve into this deeper in another article, but the Thornhill or dividend investing approach is incredibly tax efficient in Australia due to franking credit refunds and the unique tax nature of retirement. Boglehead investors wanting to sell down parcels of shares can also take advantage of a 50% CGT exemption for holding them over a 12 month period, but they are still exposed to the risk of timing the market to do so. So the LICs provide a great product with regular, increasing and highly tax effective dividends, which aren’t really affected by market fluctuations, as well as the ability to purchase it at a discount.
Seriously, just tell me which one do I buy??
OK so with a bit of background between ETFs and LICs and why I like them both, here are the four factors when I consider my purchase. They are not necessarily in order of ranking, but this is the order I generally look at it.
- Whichever LIC has the biggest discount to its value, using published NTA or NAV figures and interpolating for the index performance or using Pat the Shufflers interpolation spreadsheet. Remember that some LICs consistently trade at a discount to value, which means the ‘market’ isn’t ‘favouring’ them now and if the business and management is solid, then your getting a good deal. One thing I look at is what I call the discount delta, which is the current discount to its regular discount rate. For example if it regularly trades at 1% below NAV, and today its trading at 2% below NAV, then it has a discount delta of only 1%, as compared to its discount of 2%. Compare the discount or the discount delta to other LICs or ETFs to get an idea of it looks relative to the market.
- Whichever ETF has gone down the most. Generally yes if the ETF has gone down that means its underlying holdings have gone down. Yes, sometimes this is linked to reduced dividends but history tells us most of the time that dividends are not explicitly tied to capital value of shares. In a market crash the business fundamentals of most companies don’t suddenly change, i.e. telcos still provide mobile phone contracts, people still buy food and use electricity. This means the companies continue to make profits and therefore the diversified dividends from ETFs (and LICs for that matter) don’t decrease the same percent as the share price drops. Therefore whenever I see RED and an ETF has gone down, in my mind I see a more attractive P/E ratio and a chance to buy future dividends at a discounted rate.
- If nothing is trading at a discount or going down, whichever has gone up the least.
- If everything is tied, I buy the lowest cost Aussie shares due to the high dividend yield and franking credit. At the moment this is Betashares A200 which is my biggest holding.
So there it is, a rough idea of how to DCA the Dip and Hold. Currently these are all invested in a personal name, but due to recently reaching my threshold portfolio passive income amount, I will be selling them all and transferring them into a trust structure. This is a more tax efficient structure as a discretionary trust can allocate portfolio gains into family members on lower tax brackets – once this tax savings offsets the administrative cost burden of the trust, its a no brainer.
Benefit 1: Emotion
By Dollar Cost Averaging, I remove the emotion factor whilst investing. When I was saving up cash, and indeed when I had a lot of cash sitting around which I had planned to use to buy a property and pay off most of it initially, investing it at times felt a bit gut wrenching. I was terrified the market would drop right after I bought it, and seeing the market grow higher and higher every day before I invested it didn’t feel any better. Dollar Cost Averaging is a way I have removed my personal fear and bias from the equation, and simply every fortnight make my regular investment decision and don’t look back.
Benefit 2: Cost base
By Dollar Cost Averaging a set amount each fortnight, in the long term I buy shares cheaper. This works because if the market rises and valuations increase, my $3000 buys less shares that fortnight. Conversely, if the market drops and valuations decrease, my $3000 buys more shares that fortnight. Overall, when you consider the cost base per share, you buy more shares at a lower price than you did for the higher price – so you get your best value for money overall.
Benefit 3: Diversification
By splitting my purchases between 8 different ETFs and LICs over Australian, US and global markets, I rest easy at night knowing I have a wide range of diversification at a rock bottom price. Whilst some of the Aussie ETFs and LICs do overlap, there is a different reasoning behind including them in the structure.
This means for me to lose all of my money, thousands of globally recognised companies would all need to collapse – still an option, but statistically insignificant. I daresay if this happened I would probably be more worried fighting off the zombie Apocalypse or finding my place in a new world order.
Benefit 4: Franking credits
Having the majority of my funds invested in the Australian market might seem like a classic case of home bias, but the franking credits are just too juicy to pass up. Especially for someone chasing FIRE, where dividend yield and tax efficiency are two major factors in quickly growing a portfolio that you can live off. More information on my post specifically about Aussie shares and Franking Credits
Benefit 5: I never need to know when to sell
With a buy and hold strategy, I never need to know when to sell. I have a smartly diversified holding of thousands of constituent companies, all being reevaluated and rebalanced for me. I never need to ever worry about getting the best price for a sale, I just sit back by the pool and sip cocktails from a coconut whilst the dividends pour in (ok maybe not the coconut thing, but you get the sentiment). This also cuts out a huge amount of money people waste on brokerage by constantly stock picking and buying/selling.
Benefit 6: Value
By purchasing a LIC at a discount or discount delta, I realise an instant profit by buying something at a price below its value. Similarly, by buying an ETF that has gone down, I am buying stocks that have gone down in value, and therefore by definition which have a higher Earnings per share or better P/E ratio.
Benefit 7: Management fees
By only buying ultra low fee ETF and low fee Index funds, I am paying bugger all in portfolio management fees. Even with my fatFIRE target of $1M, I would on average be paying a MER of .1% or $1000 per year in management fees. You’d spend more every year if you went out for a $100 dinner once a month!
Benefit 8: Free portfolio tracking
Because I have less than ten holdings, I qualify for a free Sharesight online portfolio tracker. This is an awesome online program which tracks all of your purchases and dividends (and sales too if your so inclined) and can spit out a tax summary at the end of the financial year to hand to your accountant.
Less than ten holdings, but own thousands of international ‘blue chip’ quality stocks? Yes please. I still have two placeholders to spare so I can gamble on a tech startups and a marijuana stock if I really want to (haha not likely though!). Even if sharesight went bust or started charging a premium, I could easily resort to manually printing the 8 tax summaries from the share registries and doing a bit of math over a few hours, but whilst I can get it for free I will!
I hope you got something out my strategy of DDH ‘DCA the dip and hold’ and that you might be able to implement it yourself or tweak your investment strategy. If you have a different strategy or another way of looking at things, let us know in the comments below!