Is Salary Sacrificing into Super Worth It?

Because I live in Australia, there are some financial ideas that are unique to Australians e.g. franking credits, negative gearing, and superannuation.

Firstly, what is superannuation? Superannuation (or super) is a retirement fund similar to the US’s 401k. When your employer pays you, they are required by law to put 9.5% of your salary into your super. This super is locked up until you are old (about 60 to 70).

Why salary sacrifice into super? Compared to many other countries, income tax is high in Australia. Any amount you earn over $37k has a 32.5% income tax rate applied to it. If you earn over $90k then any amount over $90k attracts a 37% income tax rate. However, suppose you earned $100k per year and you arranged with your employer to salary sacrifice $10k into your super fund, then this means that rather than paying $3700 tax on that $10k and receiving $6300 in your bank account, you instead have that $10k go into your super fund and where it is taxed at only 15% i.e. you pay $1500 tax. This means you save $2200 per year assuming you salary sacrifice $10k per year.

If the tax benefits are so good, why not salary sacrifice everything into super? The answer is that there is a limit. The amount your employer puts in (9.5%) and the amount you salary sacrifice cannot exceed $25k per year. Take the example of someone who earns $100k. This figure does not include super. The employer is paying $9500 (9.5% of $100k) per year into superannuation by law. However, if the worker wants to top this up by salary sacrificing, they should simply find the difference between $25k and the compulsory contribution amount ($9500) and then salary sacrifice this amount. In this case, the person earning $100k should salary sacrifice $15500 per year to fully take advantage of the tax benefits. If you get paid every fortnight, simply divide this by 26 and therefore salary sacrifice $596 per fortnight. In my opinion, you should always salary sacrifice a little bit below the limit because your salary will likely increase bit by bit over time. If the amount you salary sacrifice is exactly $25k then the next salary increase (e.g. due to inflation correction) can tip you over the $25k mark, which leads to punitive taxes applied to you. Therefore, I recommend aiming for $23k or $24k just to be safe.

Using the example of earning $100k per year, if you are salary sacrificing $10k per year you’d save $2200 per year. If you salary sacrifice to the max then you’d be making $3410 per year.

Assuming you save $3410 per year over 30 year, then assuming 8% per annum returns, you’d have $250k.

What are the downsides of salary sacrificing into super?

Even though there are tax benefits, the main disadvantage of salary sacrificing into your super fund is that you do not get access to this money until you are around 60 to 70. However, there are hardship provisions in superannuation that allows you to access your super under severe financial hardship. Given that I am a long-term investor, I normally buy and hold investments forever. I will only ever sell if there is severe financial hardship. Therefore, keeping money in super doesn’t make much difference. For most people who do not salary sacrifice into super, their main reason is that they need to pay the mortgage, but they are simply building up savings in their house, and because houses have high transaction costs, chances are they will only sell the house under severe financial hardship as well.

One common argument people use against superannuation is that the “rules can change.” That is, while your money is locked up in superannuation, the government could change the rules and e.g. increase taxes on it. However, this is not a good argument. The risk of government changing rules or legislation apply to all investments. For example, if you do not salary sacrifice and invest in property and shares outside of super, the upcoming proposed changes to negative gearing, capital gains tax and franking credits will affect you. Unless you invest in offshore accounts or cryptocurrency, you are at risk of “rules changing,” and even if you invest in, say, offshore accounts, then offshore jurisdictions are subject to changes in legislation, and cryptocurrency protocols can change, leading to “hard forks.” You can never escape the risk of legislative or protocol amendment. The only way to mitigate this risk is to diversify.

The key downside of salary sacrificing into super is that you do not get passive income, which impacts on your ability to be finacnially independent. If you salary sacrifice $10k into super, that $10k does not produce dividends that go into your bank account for spending. It simply accrues in the super fund and accumulates until you are, say, 60. This means that if you seek to be financially independent quickly or retire very early, salary sacrificing into super can be a problem. However, there are workarounds.

The four percent rule

The four percent rule states that when you retire you spend 4% per year. Suppose you retire with $1 million in net worth. You simply spend $40k per year. Now suppose you had $500k in super and $500k outside super. One strategy is to continue to use the 4% rule but to retire at a time such that you can use the 4% rule and then time it so that you run out of your $500k outside of super just before you have access to superannuation.

Coast FI or Barista FI

Another option is called “coast FI” or “barista FI” which are terms used among the online FIRE community (financial indepence retire early). Basically you can salary sacrifice to the max early in your career such that you have, say, $200k in super by age 30. Assuming 8% per annum growth, then this $200k in super will become $2 million by age 60 assuming no extra contributions. Therefore, through aggressive early savings, your 60s are covered. Having $2 million when you are 60 is more than enough. However, because you have locked up a considerable amount of money into super, you may live a lower standard of living up until you are 60.

One solution to this suggested by the FIRE community is “coast FI” which sadly has nothing to do with the Gold Coast. Rather, you coast to your 60s by taking it easy and doing easy jobs (e.g. a barista, although based on what I have seen being a barista is quite difficult). However, in my opinion, this is not a good strategy because even easy work is still work, and there is no guarantee that you will be able to find easy work in the upcoming age of automation. The whole point of financial independence is to enable you to live without a job so that you can pursue whatever you are passionate about.

Although there are problems with barista FI, the insight that barista FI brings up is that you don’t need to retire early. Once you live off dividends, rather than retire and stop working, you can keep working but simply don’t work as hard. You don’t need to work as a barista, but you can work the current job you work but simply work in a more relaxed manner. This may mean you spend more time at work chatting to coworkers or it may mean you work part-time and take more holidays. A more mainstream term for this is “semi-retirement.” Another option is to change jobs and do something you are passionate about e.g. you may build online social enterprises that help the world.

The solution to the superannuation dilemma

Superannuation presents many Australians with a complicated dilemma. Either you salary sacrifice and increase your wealth thanks to tax benefits but lock your money up unitl you are very old, or you do not salary sacrifice, reduce your wealth, but reach financial independence faster.

In my opinion, you should salary sacrifice to the max early in your career. However, to accelerate your chances of becoming financially independent as fast as possible, live as minimalist a life as possible (e.g. living with roommates or with parents, riding bikes or taking public transport, never having children, etc) and then with your money outside of super apply the Peter Thornhill approach by investing all your money into high dividend paying Australian equity ETFs and LICs (e.g. VHY, IHD, RARI, EINC, RINC, BKI, AFI, and ARG). Because Australian equities are blessed with high dividend yield and franking credits, this coupled with a highly minimalist lifestyle will allow you to quickly achieve financial independence. To use some example numbers, the cost of a sharehouse found via Gumtree or Facebook is about $700 per month. The cost of meal replacement drink Aussielent (which I use as the basis for the cost of food) is $256 per month. Then if you get a bike then you can cover all necessities for $1000 per month or $12,000 per year. Assuming dividend yield of 7% then this means you need to save up $170k. Adding income tax and offsetting it with franking credits, this means you’ll only need to save up about $200k in high dividend ETFs or LICs to be able to be financially independent. After you have $200k, you can start to diversify your portfolio away from Australian equity to reduce risk (e.g. into bonds and international equities). Then over time, as your dividend income increases, you can slowly increase your living standards, e.g. live by yourself rather than with housemates or parents. You can eat tastier food rather than Aussielent, etc. However, for the sake of financial indpendence, your living expenses should not exceed your passive income because you must minimise the amount of time you are dependent on your job.

Because you salary sacrifice into super, there is a good chance a large chunk of your net worth will be in illiquid assets, so your living standards will be low up until you are 60 and then suddenly after 60 you will have a very high standard of living.

Retirement (or semi-retirement) in Southeast Asia

If you salary sacrifice into super, you will have a considerable amount of money in your 60s or 70s, but before you are old, you will likely live a minimalist lifestyle assuming you live off dividends. A way to increase your standard of living is to retire early in Southeast Asia where the cost of living is lower. Before I spoke about how $1000 per month is enough to live a very minimalist lifestyle in Australia, but in many Southeast Asian cities e.g. Chiang Mai, Ubud or Sihanoukville, $1000 per month can afford a more comfortable standard of living. You can retire early and then come back to Australia in your 60s to collect your superannuation and then retire in Australia. Because Southeast Asia is a bit “rougher” than Australia, younger people in their forties or fifties can tolerate it better, so if you end up retiring early in your forties or fifties living off dividends, you can go to Southeast Asia for retirement and then come back to Australia to cash out your super. One of the benefits of living in Australia is its socialist healthcare system (Medicare) that provides free medical care for all. This is particularly useful for older people. That being said, if you reach the age of 60 or 70 with net worth of $2 million, that sort of money can buy good healthcare even in e.g. Thailand. Cities such as Bangkok have international-standard private hospitals that many people from all over the world travel to for medical treatment.

Disclosure: I currently own IHD.

ETFs (and other ASX-listed Products) that Pay Monthly Distributions

“If we have food and covering, with these we shall be content.” ~1 Timothy 6:8

Some time ago I wrote about the Betashares Australian Dividend Harvestor Fund (HVST), which as of now has a very high dividend yield (about 9%) and pays monthly distributions. Monthly distributions are very convenient if you are living off passive income because, for day-to-day expenses such as food, it is more convenient to receive your payment more frequently. Most ETFs pay distributions every quarter, which is quite a long time to wait.

That being said, quarterly or even yearly distributions may be convenient for spending on things you spend less frequently on e.g. a holiday. Suppose you had $100k invested returning 4% dividends. This is $4k per year but paid monthly this would be $333 per month, which means if you wanted to save up for a holiday you’d need to take that $333 per month and put it in a savings account and wait for it to accumulate to $4k before you take an annual holiday. However, if you put that $100k into an ETF that pays yearly distributions, then you’d get $4k once a year, and when you get your $4k, you can go ahead and book your flights and hotels online. The fact that the ETF pays yearly rather than monthly distributions acts to force you to save for those expenses that occur yearly (typically a holiday).

Therefore, I think it is useful to have a mixture of distribution payment frequencies to match what you spend your money on. However, when it comes to financial independence, you shouldn’t focus on holidays first. You should focus on the necessities, and even though I am an atheist, I like to quote 1 Timothy 6:8 in this instance: “If we have food and covering, with these we shall be content.” In many translations of the bible, it claims that you should be content with “food and raiment,” and the word “raiment” is often translated as referring to clothing, but really raiment refers to covering, i.e. not only clothing but also shelter i.e. four walls and a roof over your head. Why am I talking about food and coverings? Because generally food and rent consist of payments we make frequently. For most people, food spending consists of going to the local supermarket to buy e.g. bread. Rent or mortgage payments are usually monthly payments to the landlord or bank. As such, it is better to have monthly passive income if you’re living off passive income while covering the necessities of life.

In my greed to secure monthly passive income to cover the cost of necessities such as bread and almond milk, I invested a reasonable amount of money into HVST, which at the time was paying about 12% dividend yield. However, the problem with high yield funds is that they are high risk funds as well. In fact, most ASX-listed products that pay high monthly passive income perform quite badly in terms of capital preservation. This may be due to the rising interest rate environment. Many high-yield ETFs and LICs that have managed to achieve reasonable capital preservation have been those that pay quarterly distributions e.g. VHY, IHD, STW, and BKI. The reason I believe this is the case is that stocks provides higher yield than e.g. bonds, but there is greater risk in stocks. Unless we are talking about variable-rate bonds, most bonds are fixed-income products, e.g. a government bond pays you a fixed coupon amount. You can therefore rely on this coupon always being paid. There is little uncertainty. Dividends from stocks, however, may vary depending on market volatility and business activity. For example, recently BHP announced it was buying back shares and paying a special dividend thanks to the sale of a US shale asset to BP. If a fund manager holds BHP, it may receive a huge dividend one day and then the next month may receive little dividends. If economic conditions are challenging, dividends may be cut. As such, if a fund manager were relying on stock dividends to pay monthly distributions, there may be times when dividends are low, which means that in order to maintain the high monthly payout, the fund needs to eat into original capital.

When focusing on financial independence, it make sense to focus on the necessities first, i.e. food and raiment rather than holidays, and given that it is more helpful to have monthly passive income to fund these expenses, I believe it is necessary to look instead at medium-yield (not high-yield) exchange-traded products that pay monthly distributions. Assuming food costs $300 per month and rent costs $700 per month then this means you need $1000 per month for necessities, which means $12k per year. You only need $150k invested earning 8% to get this. This is the allure of high-yield funds. However, with high yield comes high risk, so a medium-yield fund may provide a good compromise.

Remembering that investing has a risk-return tradeoff, and remembering that food and raiment are necessities (you cannot live without food and covering), we should not rely on high-yield high-risk investment to fund necessities. We should at least rely on medium-yield medium-risk investments to fund necessities.

I make these comments because recently I have purchased Betashares’s hybrid ETF (HBRD), which pays about 4% monthly. I have found that HBRD pays very reliable income, almost the same every month whereas virtually all other investments pay variable passive income. Looking at the Bloomberg price chart of HBRD below, you can see that HBRD (in black) is somewhat correlated to the XJO (represented in orange by the STW ETF) but with a lower volatility (or lower beta). This makes sense because hybrids are lower risk than stocks but are riskier than bonds. (Hence they are hybrids as they have bond-like and stock-like characteristics.)

HBRD (in black) has lower volatility than XJO (in orange)
Source: Bloomberg

In fact, Betashares seems to have learned its lesson from HVST and have introduced a slew of other medium-risk ETFs (e.g. CRED and now BNDS) that pay monthly distirbutions to complement their existing inventory of low-risk income ETFs (e.g. AAA and QPON) and high-risk income ETFs (HVST, YMAX, EINC, and RINC).

Below is a table of ASX-listed products (mostly ETFs, LICs, and LITs) that pay monthly distributions. The products below are sorted by risk/yield. I have used my judgement to classify these are high, medium or low yield. Generally high-yield investments derive income from stocks and pay around 5% to 10% yield, medium-risk investments derive income from hybrids and corporate bonds and pay around 3% to 5% yield whereas low-risk investments derive income from cash deposits and government bonds and pay around 1% to 3% yield. Some of these products invest in highly risky areas e.g. QRI will invest in commercial real estate debt. Note that some of these investments have not been released yet and that this is a personal list that I keep that may not include all ASX-listed investments that pay monthly passive income. If I have missed any, please notify me in the comments section.

ASX TickerNameYield
HVSTBetaShares Australian Dividend Harvester FundHigh
PL8Plato Income Maximiser LimitedHigh
QRIQualitas Real Estate Income FundHigh
AODAurora Dividend Income Trust High
EIGAEinvest Income Generator Fund High
GCIGryphon Capital Income TrustHigh
MXTMCP Master Income TrustHigh
HBRDBetaShares Active Australian Hybrids FundMedium
CREDBetaShares Australian Investment Grade Corporate Bond ETFMedium
BNDSBetaShares Legg Mason Australian Bond Fund Medium
QPONBetaShares Australian Bank Senior Floating Rate Bond ETFLow
AAABetaShares Australian High Interest Cash ETFLow
BILLiShares Core Cash ETFLow

Disclosure: My investments include BHP, IHD, HVST, AOD, HBRD, and AAA.

How to Prepare for Upcoming Stagflation

Recently markets have been shook by rising interest rates in the US. Interest rates around the world are somewhat correlated because of globalization. Australian banks often borrow from overseas (even from the US), so if interest rates rise overseas, this affects the cost that Australian banks pay to borrow money. The ASX200 chart below shows the correction in recent weeks.

the beginning of an xjo crash september 2018
Source: Bloomberg

How may the stock market crash?

Even though it is not wise to try to predict markets, my hunch is that a very large correction is near, but it may be delayed until around 2020. During the 2009 GFC, the threat was deflation i.e. prices going down, which means prices of e.g. property and shares went down as well. The solution to this was unprecedented money printing around the world. The printed money was used to purchase government bonds (in the US) or even stocks or ETFs directly (in Japan). When there is deflation, money printing is an easy fix because money printing puts more money into the economy, generating inflation, which cancels out deflation.

However, this time the fear is that when the market crashes, it is not a deflationary crash. Rather, we have a downturn while there is inflation at the same time. Why would there be inflation at the same time as a downturn? For example, take the US-China trade war. If US companies and consumers cannot import cheap goods from overseas, consumers and US businesses face higher costs. Higher costs cut into margins, which reduce profits, which reduce stock prices. If the trade wars heat up, US equities should decline futher as inflation increases. Usually when there is inflation, the central bank can combat inflation by raising interest rates. However, US businesses are already highly indebted. If the US central bank (the Federal Reserve) increases interest rates to combat inflation, businesses face higher interest expenses, which cuts into their profit margins and reduces stock price.

This dilemma that the Fed faces, in my opinion, will present a problem in the future and may usher in a 1970s-style stagflationary recession.

What can be done to protect against a downturn?

In a previous post, I spoke about the importance of the “age in bonds” rule. The “age in bonds” rule is just a guide. It doesn’t literally mean you must hold your age in bonds (e.g. if you are 30 then you hold 30% bonds).  “Age in bonds” is a rule of thumb. The complication comes from the fact that some bonds are risky (e.g. emerging market bonds, corporate bonds, etc) whereas some shares are arguably safe (e.g. utilities, gold mining stocks, etc). The basic principle behind “age in bonds” is to reduce risk or volatility in your portfolio as you are nearing retirement so that you are not exposed to e.g. a 50% decline in your wealth just before you retire.

“My personal, non-retirement accounts are about 80 percent bonds and 20 percent stocks, reflecting my old rule of thumb that your bond allocation should roughly equal your age. It’s spread across different bond funds, like the Vanguard Intermediate-Term Tax-Exempt (VWITX). I’m a pretty conservative guy.”

~Jack Bogle, Vanguard Group Founder

Given that I live off dividends, consider myself somewhat semi-retired, and don’t really have a fixed retirement date, I feel it is wise for me to reduce risk in my portfolio much moreso than the average person. For the average person in their 20s or 30s, they may feel that they don’t need to worry about a huge market correction because they can simply make up for the lost wealth by working longer. However, I don’t like the idea of being forced to work when I don’t need to.

Furthermore, even though many people feel as if they can withstand a huge market crash, if a 70% decline eventually does occurs and the reality hits that they have lost hundreds of thousands of dollars without any guarantee that the market will recover in the long run (remember that in the recovery may be many decades away and may be in the next century), I feel that many people would succumb to panic.

Which ETFs perform best in a bear market?

During the recent market correction, I was observing the reaction of different ETFs. What I found interesting is that MNRS, a gold mining ETF, shot up as the XJO went down. See the Bloomberg chart below, which shows MNRS (in yellow) shooting up as the XJO (in black) heads down.

xjo MNRS HBRD QAU and BOND during september 2018 correction
Source: Bloomberg

The large increase in gold mining stocks contrasts with the price of gold, which is represented above by the QAU ETF (in red), which holds physical gold. This makes sense since holding pure gold only provides you with access to gold whereas gold miners usually hold debt, which means they are leveraged to gold. The blue and aqua above show hybrid and bond ETFs, which both remain very stable.

Looking at the last six months, we can see how these ETFs perform not only during a bear market but also during a bull market. We can see that as the XJO goes up, the gold mining ETF and physical gold ETFs go down, which is not ideal. The bond and hybrid ETFs are stable as expected.

Gold miners and bonds vs stocks
Source: Bloomberg

What does this tell us? If you were shaken up by the recent market correction and feel that more risk is coming, a quick way to reduce risk in your portfolio is to buy physical gold and gold mining ETFs. This can be ideal if you don’t want sell shares and trigger capital gains tax. Gold miners are also legitimate companies in their own right. However, the problem with physical gold is that it pays zero passive income, and gold miners historically pay little in dividends. In contrast, the government bond ETF (BOND) pays about 2% in yield whereas the bank hybrid ETF (HBRD) pays about 3% to 4% in monthly distributions, so if you feel you have far too much risk in your portfolio, you can correct it fast by buying gold, but once you have derisked your portfolio sufficiently but still want to tread cautiously, you can take advantage of passive income with bond and hybrids, as well as some high dividend ETFs as well (e.g. IHD, VHY, EINC, etc).

Top 10 ASX ETFs or LICs

See below a chart providing a ranking of the best income-producing ETFs or LICs on the ASX. The chart below updates in real time and estimates future income returns (including franking credits) based on historic returns. Past performance does not guarantee future performance. The chart below is not exhaustive and does not include all ETFs and LICs.

Betashares Legg Mason Income ETFs (EINC and RINC)

I invested a fair chunk of money into the Betashares Dividend Harvestor Fund (HVST), and while this fund pays great monthly dividends (approx 14% now), its price performance is lacking, as the chart below shows. (Read The Problem with HVST.)

Screenshot 2018-03-12 at 12.26.37 PM

HVST price as of 12 March 2018 – Source: Bloomberg

To address this issue, I have simply opted for a 50% dividend reinvestment plan, which will see half the dividends go back into buying units in the ETF in order to maintain value. Assuming HVST continues to pay 14% yield and that 50% DRP is enough to prevent capital loss, HVST still provides 7% monthly distributions, which in my opinion is fairly good. Generating sufficient monthly distributions is very convenient for those who live off dividends as waiting three months for the next dividend payment can seem like a long wait.

However, Betashares have now introduced two new ETFs on the ASX (EINC and RINC) based on existing managed funds from fund manager Legg Mason. Based on the performance of the equivalent Legg Mason unlisted managed funds, these ETFs are very promising for those who live off passive income. These ETFs have high dividend income (around 6 to 7 percent yield) paid quarterly, and based on past performance at least, there doesn’t seem to be any issue with loss of capital.

RINC (Betashares Legg Mason Martin Currie Real Asset Income ETF) derives its income from companies that own real assets such as real estate, utilities, and infrastructure whereas EINC (Betashares Legg Mason Martin Currie Equity Income ETF) derives its income from broad Australian equities.

The expense ratio of 0.85% is on the high side but not unsual for this type of fund (income focussed and actively managed). Another potential risk to consider is the impact that rising interest rates can have on many of these investments, especially “bond proxies,” into which RINC and EINC seem to invest exclusively.

Vanguard Australia Diversified ETFs – The Only Investments You’ll Need?

Vanguard has always had diversified managed fund. I remember using these many years ago, but I stopped adding money into these funds as I was distracted by other new investments. However, when I look back the performance of my investments, I am blown away by the returns from these Vanguard diversified managed funds, and they pay regular quarterly distributions into my bank account.

Furthermore, at the end of the financial year, Vanguard provides a full tax summary that you can simply give to your accountant (I use H&R Block). For simplicity and effectiveness, investing in Vanguard and getting H&R Block to manage your taxes is, in my opinion, a foolproof strategy.

One of the main issues with Vanguard’s diversified managed fund was that its fees were quite high. However, recently Vanguard has released their suite of four diversified ETFs:

  • Vanguard Conservative Index ETF (VDCO)
  • Vanguard Balanced Index ETF (VDBA)
  • Vanguard Growth Index ETF (VDGR)
  • Vanguard High Growth Index ETF (VDHG).

Investors now only need to determine how much risk they are willing to tolerate and then allocate money appropriately, e.g. if you are willing to take on more risk then invest in VDHG whereas if you want to take less risk you pick VDCO. Everything else is handled by Vanguard, which makes investing simple and easy.

These ETFs can be purchased off the ASX, which can be done with an online broker such as CommSec. I try to purchase ETFs in $25,000 increments on CommSec as the fee is $30, which is the most bang for your buck.

Most financial advice follows the “age in bonds” principle whereby you own your age in government bonds, e.g. if you’re 30 then 30% of your wealth is in government bonds. Whether you strictly follow “age in bonds” or not, the main principle is that as you are nearing retirement you reduce risk in your portfolio. With Vanguard diversified ETFs, you can simply carry this out by buying VDHG when you’re young but as you get older you start to buy more VDCO to reduce risk. Although not exactly conforming to “age in bonds”, “age in VDCO” is a simple alternative rule-of-thumb. For example, if you’re 30, own 30% VDCO and 70% VDHG. As you buy, simply buy whichever ETF you’re underweight in.

I love to dabble in new exotic investments such as ROBO and cryptocurrencies, but I try to follow the core-satellite approach, which states that you limit exotic investments (the “satellite”) to a small portion of your portfolio (e.g. only 30%) while the bulk of your investments (the “core”) are in low-cost passive index funds. Vanguard’s diversified ETFs are perfect investments to take the role of “core” investments.

More information can be found at Vanguard Australia’s official website on its diversified ETFs.

For those who prefer managed funds rather than ETFs, see below Vanguard Australia’s page on its diversified managed funds.

The Problem with HVST (Betashares Australian Dividend Harvester Fund)

For probably two years now I have been buying up the Betashares Australian Dividend Harvester Fund (HVST), which is a exchange traded managed fund listed on the ASX. The appeal of this fund is that it pays a very high dividend yield (about 10% to 14%) and pays this dividend monthly. The monthly dividend payment normally gets paid into my bank account in the middle of the month, and every payment is roughly the same. Hence HVST makes living off dividends very easy. This is why I have accumulated over $100k worth of HVST.

However, it is becoming increasingly clear that there are many flaws with this fund, the main one being that it has not performed well in the last few year compared to the ASX 200.

HVST vs ASX 200 from 2014 to 2017
HVST has significantly underperformed the ASX 200 over the last few years (chart from CommSec).

That being said, I am not criticizing the fund or Betashares. I was well aware that the dividend harvesting technique employed by the firm would result in less upside when markets were going up. This is a result of the fund manager buying high dividend paying stock just before dividends are paid and then selling the stock after the dividend is paid. As stock prices normally go down after dividend payment (as the company’s value goes down in line with its reduction in cash) then naturally a dividend harvesting technique would result in lower capital gains.

Something else surprising is that during downturns in the ASX 200, HVST also went down considerably as well, which makes me question the firm’s risk management overlay employed. According to the article Managing risk: the toxic combination of market downturns and withdrawals in retirement on the Betashares Blog:

One way to help manage sequencing risk is to apply a dynamic risk exposure strategy, which seeks to reduce downside market risk…. BetaShares combined its expertise with Milliman to launch the BetaShares Australian Dividend Harvester Fund (managed fund) last November. The fund invests in large-cap Australian shares with the objective of delivering franked income that is at least double the yield of the Australian broad sharemarket while reducing volatility and managing downside risk.

Based on this description, I was hoping that the fund’s risk management overlay would reduce downside movements, but the chart of the performance of HVST against XJO shows that when XJO turns downwards, HVST goes down by as much. When XJO goes up, HVST tends not to go up much if at all, which results in HVST falling by about 20% over the last few years while XJO has managed to increase in value by a modest 5% during the same time period.

As I said, this does not mean I will not continue to invest in this fund. The regular and high monthly dividend payments are extremely convenient, and any capital losses made by the fund over time, in my opinion, can be compensated for by investing in ETFs in riskier sectors e.g. investing in tech stocks, emerging market, or small caps or even by investing in internally leveraged ETFs such as GEAR. For example, if you invest half your money in HVST and half in GEAR, you get the convenience of monthly regular dividends from HVST and any capital loss is compensated for with your investment in GEAR which should magnify upside market moves. Note that a limitation of the half HVST and half GEAR strategy is that when the market goes down, GEAR will go down significantly as well. Furthermore, another problem with both GEAR and HVST is that they have management expense ratios that are significantly higher than broad-based index ETFs mostly from Vanguard or iShares. Both HVST and GEAR have management expense ratios of 0.80 percent whereas Vanguard’s VAS is 0.14 percent and iShares’s IVV is 0.04 percent.

Nevertheless, I do recommend many products from Betashares. One ETF that I am interested in from Betashares is their new sustainable ETF called the Betashares Global Sustainability Leaders ETF (ETHI). I normally buy ETFs in batches of $10k to $25k at a time, so I intend to buy a batch of ETHI and write a blog post about it later. I have mostly positive views about Betashares as they provide a great deal of innovative ETFs.

Update 18 June 2017: The poor price performance of HVST is explained in the Betashares blog article Capital vs. Total Return: How to correctly assess your Fund’s performance. If performance includes income as well as franking credits, the gross performance of HVST looks more favourable.