Financials Tracking

There was some discussion recently in the MMM forum. The context was tracking the cost base of share parcels for capital gains tax. I promised to share how I go about this and monitoring overall financials with my spreadsheet. Sorry, I’m not going to provide a template, just a description of how I do it. I believe in DIY and encourage people to take ownership by building their own tools. Furthermore, I’m not even sure if what I’m doing is a best practice worth sharing, it’s just what I’m doing.

My spreadsheet has evolved over time. Initially the purpose was Net Worth tracking. This extended to calculating the Asset Allocation. Then I added Transaction and Dividend’s history, as well as several other adhoc worksheets which I will not mention here, seeing as they are “adhoc”.

Net Worth worksheet

This is basically a balance sheet for those who have done any accounting. List out all your assets and liabilities. I use the following headings : Property, Shares, Cash/Term Deposit/Fixed Interest, Superannuation, Tax. Under each heading, include separate rows to list specific assets or sub categories. E.g. Under property you might have PPOR (Primary Place of residence), IP1 (Investment property 1), IP2, ..... Sub categories for shares might be – Australian Direct holdings, Australia ETF, Global ex US, US, Global hedged. Cash/TD/FI and Super are self explanatory. Under Tax I include known liabilities, e.g. Capital Gains Tax on IP’s that I intend to sell one day. You might also have Income Tax liabilities accruing. I don’t include potential CGT on shares since I intend to hold the shares “forever”.   Then the columns are Asset value, debt owing, Net income, Yield. Note - The last two are not “balance sheet” items, but I also use this to calculate my passive income so they are needed.

After completing the resultant table, you should be able to calculate Net Worth, which is the sum of all the asset values less the debt owing on those assets. For my purposes, I don’t include personal assets (e.g. contents, cars) in this.

As mentioned earlier, this was the original intent of the spreadsheet. To keep a track of NW as the basic goal post for our progress towards FI. However over time it evolved and I also wanted to add in Asset Allocation. To the right of the NW balance sheet, I added a table for Asset Allocation. This breaks down the assets into the various asset classes : Growth (Aus Shares, Global shares, Property) and Defensive (Cash, FI, TD). You will need to include your superannuation asset allocation, to translate the super balance into these asset class categories. I also subtract my “emergency fund” from the Cash, to keep this outside the Asset Allocation. I construct the table to show my AA inside and outside Super, as well as the overall/combined AA. Then I include my target AA and the delta between Actual and Target. I have some conditional formatting to highlight in green or red those positive and negative deltas (for those inclined to add such bells and whistles). This is how I manage my investments to try and keep in line with the plan. As we are still making regular contributions, I stay balanced by investing the next chunk in the asset class that is below target. This avoids making sales and incurring extra transaction costs and incurring capital gains/losses.

Trades Log worksheet

This is where I track of all my transactions. Everytime I transact any shares, ETF’s, managed funds or super contributions, I keep a log of it here. I also include and shares bought under DRP’s (Dividend Reinvestment Plans). This requires some discipline to update the spreadsheet everytime, but I think it’s a simple and quick task and helps me cross check to ensure nothing goes missing. The columns are date, name, category (e.g. Shares, ETF, Mgd Fund, Super), $, Units, Price, Brokerage, Other Costs, Tax deferred income (each year a new column), Cost Base.

The further functions of this sheet are :

CG cost base : Calculate the cost base for CGT for each parcel. For ETF’s with tax deferred income, this is updated at the end of each tax year to show the reduction in cost base due to tax deferred income in these funds.

Cross link to NW worksheet : Every time I add purchases to my core portfolio (which is basically four ETFs – VAS IOZ VTS and VEU) , this is automatically updated in the NW Worksheet using a sumif() formula that cross links to the Trades Log. That makes it very easy and effortless to see the latest impact on Asset Allocation as soon as new trades are entered and the current ETF prices are input. It can also be used to do “what if” analysis by adding in future purchases and see how much of each ETF is needed to achieve the desired AA.

Dividends worksheet

This worksheet is used to track dividends. Each line is a dividend or distribution. The columns record the details, i.e. Record date, Payment date, c/share, Franked Dividend, Unfranked Dividend, Franking credit, Withholding tax, FX rate (if applicable), etc. Again it requires a small effort. Everytime I receive an electronic dividend statement, at the same time as e-filing this away, I just enter the data as a new row in this worksheet. It comes in handy at tax time to cross check whatever is pre-filled in your eTax. It can also help monitor your expected dividend income, in case you want to take any actions to optimise your tax (e.g. making voluntary after tax super contributions which might be deductible if you are self-employed or unemployed).

Other useful features

One big bonus is the auto-filter function in Excel. I use it on both the Trades Log and Dividends worksheet. That way I can easily sort data to answer questions such as – How much have I invested in the past few months ? How many transactions did I make in the last financial year ? How much have I contributed to super (after tax) versus the concessional limit? What is my total purchase cost for VAS ? How much dividends have I received for VAS ? etc. There is much more you can do with structured data using pivot tables, but I haven’t found the need as yet.

How do I invest ? -- update --

Just a brief update on asset allocation. After the recent sharemarket dip, especially on the ASX relative to global shares, I decided to adjust my AA a little. No big changes. I have also been pouring some money into shares at these more attractive levels, so coming closer to target AA but still remain underinvested and have some way to go.

Updated target allocation is 65% growth / 35% defensive (instead of 70% growth / 30% defensive). I consider these +/- 5%, e.g. 60-70% growth and 30-40% defensive.  Current mix is 59% / 41%, so good progress on investing the lump sum and I can allow myself some small pleasure in the decision not to throw it all in the market back in April/May ! I plan to keep investing actively in the next month to get to the target 65% or very close at least.

The asset class split is as follows. The main change is the Aus/global share split now at 60/40%. I just see better value in the ASX, the yield is too enticing and with the AUD corrected down to a long-term fair value the upside for global shares is much less. Having tweaked a bit here and there, I intend to set this in stone now. The plan is to get portfolio in line with target allocations in the near term (next few months) and then stick to it as best as possible.

GROWTH

Australia shares (mainly ETF but also some direct blue chips) = 39%  [prev 38.5%]

Global shares = 26% (target around 3% of this AUD hedged)        [prev. 31.5%]

Commercial property = 0%

DEFENSIVE

Aus Fixed interest (including term deposits) = 8.7%     [prev 7.5%]

 Global FI = 0%

Cash (includes high interest saving accounts) =  26.3%   [prev 22.5%]

 

How do I invest ?

The aim of this post is to share how I’m approaching our investments as an early retiree. Please do not consider any of this as financial advice or recommendation. It’s really just a description of what we’re doing, which may or may not be good for us, let alone for your circumstances which I have no idea about!

Basically I view our portfolio in two parts : A ) residential property and B ) the rest (includes super).

At the point of retiring early, the split was 57% / 43% (of which 10% super). This split excludes the value of our own home in Australia and a cash emergency fund.

We immediately sold the overseas property we were staying in. This shifted the ratio to 42% / 58% and left us with a large lump sum to invest. I would like to reduce our property exposure A) further and firmly intend to sell at least one more property in the next 5 years. As for the lump sum, we invested about a third of it in index ETF’s and the rest is in high interest accounts. I intend to dollar cost average it over the next year or two. More on this later.

I probably better say a bit more about the investment strategy for B)...

I view the asset allocation on an overall basis with super included. My target allocation is 70% growth / 30% defensive. The asset classes I invest in and target allocations are as follows :

GROWTH

Australia shares (mainly ETF but also some direct blue chips) = 38.5%

Global shares = 31.5% (target around 3% of this AUD hedged)

Commercial property = 0%

DEFENSIVE

Aus Fixed interest (including term deposits) = 7.5%

 Global FI = 0%

Cash (includes high interest saving accounts) = 22.5%

 

A bit of explanation, starting with the portfolio exclusions...

I’m not keen on commodities, hedge funds, private equity, etc. Commods : I just don’t buy the arguments about diversification / inflation hedging, and I don’t see them as being assets worth holding for any other reason. HF/PE : very high in fees and again I’m not convinced they bring the diversification benefits many others hope for.

Commercial property, I feel there’s already enough in the ASX, not to mention my own overweight residential portfolio.

Global FI. I don’t want to touch it in this world of zero interest rates and QE. Even Aus FI I have set quite low for the same reason. I believe interest rates are at an extreme setting and they will eventually normalise. Once that happens I will be willing to invest a bit more of my defensive into FI, perhaps half or even a bit more of the defensive part.

For the shares I have split it 55% Aus / 45% global. I have been keen on 50/50 (as I’ve discussed quite a bit in the MMM forums), but eventually tilted a bit to the local as the franking credits and yield are ever so alluring. It’s also a pragmatic issue, as my international is held in VTS/VEU which do not allow dividend reinvestment. Whereas my Aus shares have a large portion of dividends reinvesting. Furthermore VEU has 5% Australia embedded. Due to these effects, it basically means if I add new contributions in a 50/50 ratio, it will roughly work out being allocated 55% Aus / 45% global. So I plan to alternate fresh fund investments every four months VAS/VTS/VAS/VEU in the same clip size.

To reiterate my position as per MMM forums, you need global shares for diversification as the ASX is highly concentrated in banks, property, mining, etc ; and gives limited exposure to Tech, pharmaceutical, heathcare etc. However there are big advantages to investing locally with the ASX high yield and franking credits. I don’t think there’s any scientific optimum, but personally I feel anywhere in the range 70/30 to 40/60 is acceptable, depending on which factors you weight the most. As it happens, my 55/45 split is at the midpoint of this...

So, after explaining the plan/strategy for B), I will backtrack to our lump sum from the overseas property sale. The actual asset allocation is currently quite divergent from target. I’m around 51% growth / 49% defensive right now. I’ll be investing decent amounts on a monthly basis until I reach the target. I’m not aiming to time the market, so I will adopt a regular pattern. On the 1st of the month I will invest 2.5k in Mrs FFA’s super. On the 10th day I will invest 20k in VAS/VTS/VEU (alternating as explained earlier). On the 20th day I will invest 2.5k in my super. This will put $30k in each of our super which is the concessional limit. And it means we’re investing 80% outside super and 20% inside. I’m not keen to add any further into super if there is no additional tax benefit (up to $30k we can tax deduct as self/unemployed). Our marginal tax rates are likely to be 19%, so super only gives a small tax benefit at 15%, which I don’t think is adequate to compensate the lengthy restrictions and regulatory risk. Of course if you are salary sacrificing and getting other tax benefits it’s a different story (hence we are maximising concessional contributions).

A caveat on market timing, if there’s a substantial correction in share prices, I will accelerate the investment plan with some additional bargain hunting purchases. I don’t intend to monitor the markets closely. But if it’s the kind of thing you hear about regardless, e.g. you see newspapers on the table with “MARKET MELTDOWN” on the front page, I will be tempted to make an extra online trade and scoop up additional cheap units. If the ASX ever heads back to 5,000 or thereabouts I will be doing this surely.

Once the asset allocation eventually reaches target, I will drop the large regular investments and maintain/rebalance periodically. There might be another big lump sum to invest when we sell the next property (we might wait a few years as it’s in perth and the market is weak there now), after which I will probably repeat this process, i.e. invest a third/half straight away and trickle the rest in over a year or two. So far the decision has paid off, as the share markets were higher back in April/May, but who knows how it will turn out. In any case, I have made this plan and I intend to stick to it.

I hope this gives you some insight into how I’m approaching our investment portfolio. It is far from perfect and there are quite a few legacy aspects that I would not repeat if I was starting over. Where possible I will try and simplify the approach and portfolio. I look forward to playing this out and see how well we can comply with the plan! Please feel free to leave any comments, suggestions or questions....

The great active vs passive investing debate

This is a huge topic, potentially a bottomless pit. There are deep theoretical arguments one can wade through about the relative merits of each approach. Then there is the more practical approach of picking out examples, or reflecting on your own experience of trying to pick stocks or time the market. It’s hard to know where to begin, but let’s try to lay down some thoughts on this.

Efficient Market Hypothesis

Starting with the theory, most economic doctrine is underpinned by this EMH premise, which makes a lot of assumptions about rational behaviour, perfect information, etc. Basically everything is already in the price thanks to the efficient market. If you believe this, then it leads towards a passive index approach, because there is no value arbitrage to be monetised via active investing.

I don’t believe markets are efficient in this sense. You just have to look at the bubbles and crashes to see that the level of price variation goes far beyond the movement in fundamental asset value. Largely this is because of human behavioural aspects, e.g. fear and greed, which defy the assumption of rational behaviour. So then, does that make me an active investor ? Well not really nowadays, but I have certainly tried over the years. Basically I evolved to the view that it is possible, but not easy, to beat the market. A safer and more reliable approach is to simply accept market returns, focus on asset allocation and minimise costs whereever possible.

Follow the smart money

It’s funny to hear phrases like this. I thought all those $20 notes were the same, but apparently some are smarter than others. And then there’s the “dumb” money going into passive index funds. Diworsification, as some traders/investors/fund managers might mock. You hear comments like “why would you want to buy the index when it means you’re going to own BHP / WOW” (or in the past it would’ve been TLS, or whatever company/sector is out of vogue). I don’t really buy into these arguments. Call me cynical, but if someone really had an investing edge to sustainably beat the market, then they should be smart enough to use it to their own advantage and bet their own money (with leverage of course). I guess most of them must hope for healthy overall market performance in which case many investors will gloss over the issue of performance vs benchmark and fees.

There is one glaring case that deserves a special mention. This of course is Warren Buffett and Berkshire Hathaway. Surely this must be the poster child for active investment. But is he the exception rather than the rule? Statistically you would have to say so.

Stock picking and market timing is foolish

At the other end of the spectrum, you will hear index advocates pan active investing as foolish and pull out any number of statistics to support their view. You will read a lot of this especially if you hang around bogleheads, MMM, etc forums. While I have gravitated towards this end of the spectrum, I am certainly not in this camp either. As I said already, I believe it is certainly possible to beat the index, just not easy. However for those who have the interest, desire and mindset, I think it certainly is a valid approach to pick stocks and/or time the market. Some of the biggest investment opportunities I have seen in my lifetime have been during market crashes (2002/3 Iraq war, 2008 GFC). If you had the temperament and conviction to buy when everyone else was running for cover, then these opportunities (that will come up a handful of times in your life) are huge shortcuts to FF. Of course, the opposite is also true. If you don’t have the temperament and discipline, then you will end up buying the bubble and selling the crash, which is a great way to extend your working career. I will say it again, it’s not easy to beat the market. One might think bottoms and tops are easily spotted on a chart, after the fact. They are much harder to see at the right end side though. And further to this, even if you can pick the top/bottom, will you have the conviction to trade it.... Or will you lose your neutral, unemotional view and get caught up in the fear/greed like most others ? I’m convinced the mindset factors are critical to success. Unfortunately human beings seem to be hard wired to fail at speculative investing. As I read somewhere, you need to reverse your natural instincts. Learn to be fearful with your losing trades (cut loss) and greedy with your winners (let profits run). Most people are fearful with their winners (worry about giving up gains / being “wrong”, take profit early) and greedy/stubborn with their losers (hold on and hope, usually as losses get magnified).

So far I’ve been talking market timing but how about stock picking - can one even hope to compete with the army of market analysts out there ? At risk of sounding like a broken record, I think it will be tough. Even to find the time to read all the annual reports and company disclosures nowadays is a challenge. Also one of the key drivers is the quality of management. Is it possible to really judge this as an amateur investor who will never be granted a private audience with the CEO and management team of a listed company ? It really takes skill and effort to succeed here, but again, I’m sure it’s possible. Personally if I had to pick one or the other, I would choose market timing as a better chance of success, purely because of the market cycles of fear and greed that you can try and gauge (provided of course that you can remain adequately detached yourself!).

Willingness, capability and need to take risk

I think that’s a quote from the bogleheads, and something I’ve found quite instructive. For me, nowadays, there is not much need to take risk. Therefore I’ve kind of ended up ditching any thoughts of active investing. Even though I believe it’s possible and I have an interest in the area, why bother if there is 1) no need and 2) bearing in mind my view that it’s not easy to achieve a positive result. If I was starting out again, or still on the journey to FF (i.e. 1) does not apply and there is a need), I guess I would be tempted to give active investing a try. It is yet another “shortcut to riches” that I have written about before. But I hope ultimately I’d have the sense to follow my own advice and stick with the boglehead approach, which I have now broadly adopted (although not in a religious way). Nearly all of it resonates with me, especially the part about minimising costs (why pay for your fund manager’s Ferrari). I think investors are spoilt nowadays to have index ETF’s with such negligible fees. Really when you think about it, having the opportunity to invest in 100’s or 1000’s of companies with a relatively small amount of capital and paying <0.2% p.a. Most people would be best served to be thankful for such facilities. Just take this easy option and find a less costly hobby. Old habits die hard though, and on the market timing front, I haven’t entirely given up : I am holding a decent cash allocation and hoping I will have the courage to “fill my boots” should another serious market panic arise in the coming years. I do slightly regret missing the previous few opportunities I’ve had in my investing lifespan.

Active investing

I’ll just finish with a few thoughts on what it might take to succeed as an active investor. As already stated, I’m not an active investor myself so take it for what it’s worth...

Firstly, should you DIY or delegate to a fund manager ? I think it depends on your capability, interest and approach. In most cases, it will be better to use a fund manager. And if you DIY, you should mentally consider it as though you are employing yourself as a fund manager. Sounds a bit silly/contrived, but basically you need to have two hats, one as the investor and another as the fund manager who works for the investor. This fund manager should prepare an investment plan, quarterly reports to review results and actions taken. The investor could even pay the fund manager (a notional payment of course, it’s all your money afterall) a fee of say 1% of funds under management, and see if this fee is recovered or even outperformed. Basically the point is you have to treat it like a pro. If you are going to be an amateur / hobbyist, then either don’t do it (use an active fund manager or go back to indexing), or keep the percentage of assets low, e.g. 20% max, to minimise the risk to your hard earned stash.

Secondly, if you decide to use an active fund manager, the question will arise of how to pick one. As many researchers have shown, past performance is not a reliable indicator. So I wouldn’t just pick the fund with the best returns last year. Really you are betting on the fund manager’s skill and capability so it makes sense to get to know the fund manager. As a minimum, read their prospectus and market reports. Do they have an active website/blog which gives good insights into their investment approach. Do you understand what they are doing and their strategy to beat the average market return ? Are their fees reasonable ? These are the questions I’d be asking myself. If all else fails, there are some Listed Investment Co’s in Australia and a very notable one in the US that have a long track record of solid performance and reasonable fees. They might be a good starting point for your research!