Aust: Help with Longterm Portfolio

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Topic Author
Z3170501
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Joined: Thu Jan 14, 2021 8:04 pm

Aust: Help with Longterm Portfolio

Post by Z3170501 »

Country of Residence: Australia
International Lifestyle: Do not expect to move country before retiring or in retirement
Currency: AUD
Emergency funds: Yes, somewhere between 3-6 months expenses
Debt: Nil
Age: Both spouses early 40s (2 dependants aged under 10)
Income: Spouse 1: $50k, Spouse 2: $150k (both before tax)
Timeframe: Approx 20 years (no specific desire for either to retire before 60)
_______________________________________________________________

Current Assets:

PPOR: Approx. $800k

Spouse 1 Superannuation:
Balance: Approx. $200k
Type: Low Cost Industry Accumulation Fund (Index Balanced Option)
Annual concessional contributions: Approx. $25k
Asset allocation: Aust. Shares 32%, Developed Market Shares 43%, Fixed Income 15%, Cash 10%

Spouse 2 Superannuation:
Balance: Approx. $570k (Notional)
Type: Defined Benefits Fund
Projected Indexed Pension in Retirement: Approx. $130k or Lump Sum: $1.4m
Note: I consider this akin to “cash or bonds”
_______________________________________________________________

Current amount available for investment: Approx. $2,400 per fortnight
_______________________________________________________________

Questions:

Given the foregoing, our plan is now to invest to accumulate long-term wealth (i.e., not for additional retirement income, etc). I have read the Passive Investing in Australia website, and a number of posts on here and elsewhere. My wife is inclined to follow the Barefoot Investor Idiot Grandson Portfolio, whereas I have no emotional attachment to his suggestions and would rather take a broader survey of options.

The Idiot Grandson Portfolio is all shares (tickers an example): Domestic (VAS, 75%), US (IVV, 10%) and Rest of World (VEU, 15%).
Alternative 1: VDHG, 100%
Alternative 2: Something like the Idiot Grandson Portfolio except in different ratios!

There is also the option of borrowing against our PPOR and purchasing an investment property (we don’t currently have a 20% deposit saved up to avoid LMI). However, we would look to do that with as close to positively geared expenses as possible - so that shouldn’t impact on the amount available to invest in shares to a huge extent.

Based on the information above, I would be grateful for assistance in putting together a simply managed portfolio that will accumulate over time (preferably with any dividends reinvested). My hesitation with simply using VDHG is the bonds - but is that enough reason not to just use it, and be done? Is there benefit to diversifying and not having 100% in a Vanguard product, etc.

Thanks in advance.
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andrew99999
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Re: Aust: Help with Longterm Portfolio

Post by andrew99999 »

Unfortunately, the "idiot grandson" portfolio was entirely a marketing stunt. He started advertising that he was doing an "analysis" of lots of funds. Left it while people waited and word spread. Then came out and said, yay, here's our highly analysed portfolio from cutting down all the funds. It turned out to be nothing more than 75% Aus index and 25% global index. i.e. marketing stunt.

Incidentally, if you switch it to 25% Australian index and 75% international index (minus the marketing nonsense) you would have a great portfolio. I wouldn't mind the silly marketing stunt if he did that, but it turned out to just overexpose people to the Australian index, which severely lacks diversification.

I would switch VTS/VEU for VGS/VGE to avoid potential legislative risk from the US-domiciled funds (VTS/VEU), but you can make your own decision on that.

That would be 25/65/10 VAS/VGS/VGE.

If the 10% bonds are the only issue with VDHG, I wouldn't consider that enough of a problem not to use a simple diversified all-in-one fund. Although, if you thought the 40% (of equities) being in the Australian market was a problem, I think that would be enough to switch. That's quite a lot of concentration risk.
Topic Author
Z3170501
Posts: 7
Joined: Thu Jan 14, 2021 8:04 pm

Re: Aust: Help with Longterm Portfolio

Post by Z3170501 »

Hi Andrew, thanks so much for the reply.
which severely lacks diversification
Is his response to this tied up in dividends? I.e., he went Aust-centric to maximise an income stream? If total growth is the same between Aust and foreign markets, then it strikes me that selling down for capital gains is actually better anyway (with the 50% discount).
If the 10% bonds are the only issue with VDHG
My only consideration of the bonds was that the defined benefits pension is more or less equivalent to that, in terms of overall asset portfolio. Even though the idea wouldn't be to rely on the longer term investments in retirement, I suppose you never know!
That's quite a lot of concentration risk
I'll go back to the PIA website to read up again on Australian market concentration risk.
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andrew99999
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Re: Aust: Help with Longterm Portfolio

Post by andrew99999 »

I can't remember the reason, but yea probably based on franking credits.

Although few people (including virtually no advisers) are aware that franking credits are mostly priced in, meaning most of the cash you get back in tax is lost through reduced capital gains.

A good DB pension is a fantastic way to fund your retirement, and I agree that it works like a bond. although 10% is a small amount of bonds. An article on that site, which I can not link to ('Does the 10% bonds in VDHG make it a no-go?') explains that 90/10 hasn't historically impacted returns 10%, but rather 3.5%.

Half the Australian index is in 10 companies and two sectors, so it is very poorly diversified.

And if you look at the past three decades, you can see that the lucky run really was nothing but luck. Australi missed the Asian crisis in the '90s, which infected country after country like a contagion. Australia is now much more tied to Asia, so I wonder if that would be different today. Australia missed the tech wreck because we have no tech. What if it was an Australian property crash when we have so much of the country's worth in property? Luckily, Australia wasn't hit badly in the GFC. The US had very high unemployment and tons of bankruptcies and foreclosures, whereas Australia was only very lightly affected. The question is whether you think Australia will continue to be so lucky or if you would risk 75% of your wealth in one market, which eventually is likely to be like the rest of the world and have a tough economic period.

Additional reasons for investing more internationally:
• Dividends are irrelevant since they're literally the proceeds of a forced sale from the value of your shares
• Tax advantages (franking credits) are largely priced-in, and what remains may be gone in the future.
• Idiosyncratic country risk (single country risk). Nobody has any idea if Australia will continue to perform well or go into an isolated economic crisis.
• Your income and job security are tied to Australia, so investing internationally reduces the risk of your income and investments going down together.
• You can improve risk-adjusted returns by investing globally.
• Exposure to sectors underweight in the Australian market (e.g. tech, and really anything not finance and mining)
• Exposure to markets growing faster than Australia (e.g. China, India)
• Currency diversification
• Global equities hedged to AUD can mitigate currency risk for a practically insignificant cost while removing idiosyncratic country risk.
Topic Author
Z3170501
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Re: Aust: Help with Longterm Portfolio

Post by Z3170501 »

I totally take your point about the Australian market being poorly diversified, and historically lucky. Also, while I’m no economist, with so much of the Australian market being in mining and resources, I do wonder how the shift to cleaner energy and the current spat with China will play out on that front. Once people stop wanting as much coal and iron ore, how lucky will we continue to be!?

I think I worked out at one point that VDHG had 90% equities and of that 40% were VAS (i.e., it had 36% overall VAS). That is higher than the 25% mooted below. It also throws in <10% of each VISM (6.3% overall) and VGE (5.4% overall). They are small holdings - and I think I read on another thread that it was suggested that <10% weren’t really significant. Is that any concern when balanced against the simplicity of a single fund? Let’s say, by way of comparison, example mooted below: 25/65/10 VAS/VGS/VGE.

If the bonds are more or less irrelevant (either way), the 40% VAS is too concentrated, and the only benefit is simplicity (which isn’t nothing), I wonder if three funds is a ‘better’ option for us.

As an aside, out of curiosity, I tried to do the calculations for the tax effectiveness of capital growth vs dividends (with franking credits built in - and I note that nothing is certain in the future on that front). My calculations may be right off - but I think at any marginal rate, it’s more tax efficient to take the dividend over capital growth (even with the 50% discount). The following assumes that the full value of the dividend and franking credit it built in:

Dividends
YR1 Cost base: $100
YR3 Market Value: $300
YR3 Dividend: $70; Franking Credit $30
YR3 Capital Proceeds: $200 (i.e., $100 Capital Gain)

YR3 Tax = ((($70 + $30) + ($100 x 50%)) x marginal rate) - $30
@19% = $1.50 refund
@32.5% = $18.75
@37% = $25.50
@45% = $37.5

Growth Only
YR1 Cost base: $100
YR3 Market Value: $300
YR3 Capital Proceeds: $300 (i.e., $200 capital gain)

YR3 Tax = (($100 x 50%) x marginal rate)
@19% = $19
@32.5% = $32.50
@37% = $37
@45% = $45

Assuming my calculations are correct (which I accept they may not be), a 30% tax offset beats 50% discounted gains. What have I missed? Or is the benefit in capital growth vs dividends substantially limited to the deferral of that income (and therefore tax). Putting aside the market concentration risk for a minute…
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andrew99999
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Re: Aust: Help with Longterm Portfolio

Post by andrew99999 »

A couple of things you missed:

1. The ability to earn money on delayed tax payments for potentially decades (and compounding of those gains). Think of it as an interest-free loan from the government.

2. Franking credits are partially priced in. The estimates I've seen from some older research suggest around 40-80% priced in. So in total return analysis, I would take off 60% of your franking credits. This is what I was referring to when I said:
few people (including virtually no advisers) are aware that franking credits are mostly priced in, meaning most of the cash you get back in tax is lost through reduced capital gains.
Topic Author
Z3170501
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Joined: Thu Jan 14, 2021 8:04 pm

Re: Aust: Help with Longterm Portfolio

Post by Z3170501 »

Thanks Andrew
Franking credits are partially priced in.
I think what I did below was fully price in the cost of the dividend and the franking credits. In the dividend scenario, the capital proceeds were only $200. In the capital growth only scenario, they were $300. But I had forgotten something very important - the net overall gain! Once you add back in the dividend income and the capital gain, the capital growth only scenarios win at each marginal rate (with the net difference increasing as marginal rates increase).
The ability to earn money on delayed tax payments
Yep, I now understand. Even with full dividend reinvestment, you have more to compound. In fact, even if you sold to realise capital gains each year (stupid hypothetical, and ignoring the 12 month requirement!), you would have more to ‘reinvest’ under the capital growth scenario.

All of that aside, I recognise the point about home bias - I was just trying to properly understand where the tax benefit was (or wasn’t).

On the bias front, would the 40% Aussie bias with VDHG be most simply eliminated with a 2-fund portfolio of something like:

VDHG: 70%
VGS: 30%

I guess it is worth querying whether that is actually much simpler than having three funds though! I don’t know enough about the costs of each fund to know whether the constant rebalancing within VDHG would outweigh any simplicity of only having 2 funds. Or whether the benefits of having a reduced amount of ‘emerging market’ (in VDHG) is outweighed by the addition of ‘small caps’.
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andrew99999
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Re: Aust: Help with Longterm Portfolio

Post by andrew99999 »

What I mean by "priced in" is that those buyers and sellers of stocks who benefit from franking credits (about half the ownership of Australian stocks are by Australians who get this benefit) are willing to pay more for those shares to get this benefit.

As a result, the price of those shares is higher. And when you pay a higher price, the return on your investment will be lower due to paying more for it.

This is what I mean by "priced in". Once you account for what is priced in, the total return of franking is lower than the cash that is paid out.

It was explained further in the article "Franking credits - how much more are you really getting".

---

Yeah, you could reduce the home country bias by adding VGS, but as you mentioned, not much different than 3 funds, and with 3 funds, you can get exactly what you want, including no bonds. But either option would be very good.
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Z3170501
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Re: Aust: Help with Longterm Portfolio

Post by Z3170501 »

Thanks so much. I appreciate the sounding board and discussion.

I suppose with a capital growth plan (little income), this largely negates the benefits of a discretionary trust (income streaming) - if the alternative is holding as individuals, then transferring directly upon death (CGT rollover) or establishing a testamentary trust.

On the basis of course that retirement income will be from other sources, and it would be hoped that selling would be rare.
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