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.

https://www.vanguardinvestments.com.au/diversifiedETFs/

The Use Case of Ethereum and Other Smart Contract Protocols #Podcast

There are many uses for ethereum smart contracts as it provides services that the traditional banking sector does not provide. The banking sector can adapt to create their own smart contract service, but this does not necessarily mean that crypto networks like ethereum or cardano will be affected.

Why the Crypto Market Is Not a Bubble #Podcast

With the rapid rise in value of the crypto market to more US$500 billion as of December 2017, many are calling cryptocurrencies a bubble simply by looking at the chart that shows prices rising substantially. However, it is important to understand that a bubble cannot be determined with reference to a steep rise in price. Rather, there is a bubble if the price is greater than the intrinsic value of the asset, and cryptos, I will argue, do have very high potential intrinsic value.

Why You Don’t Need Debt

I do have debt, but it’s a small amount. For example, I have credit cards, but I always pay it off before there is interest. I also have a margin loan, but I have this so I can buy easily when the opportunity presents itself, and I try to pay off any debt quickly.

Many people talk about how debt is a tool for making money, and theoretically this can be true. For example, if you borrow at 4% from the bank and invest in something an asset, e.g. an investment property that makes 8% then you make a profit. However, if you borrow money from the bank to invest, you need to ask yourself why the bank didn’t invest in that investment itself. The answer is that it is risky.

Banks have a certain level of risk they are willing to take. The property could have gone up 8% but there is no guarantee that it will. If there were a guarantee that the property would go up 8% then the bank would simply invest in it rather than let you borrow money to invest in it. By letting someone else borrow money to invest in the house, the bank effectively transfers risk. If the bank vets the borrower to make sure they e.g. have high enough income, etc and if there were clauses in the contract enabling the bank to seize assets in the event of default, then that 4% the bank makes is almost risk free.

But don’t you need to take on more risk to make more return?

Risk appetite is a very personal topic because everyone has different risk appetite. Generally speaking, it is recommended that young people take on more risk because they have greater ability (and time) to recover should something go wrong. This is the main principle behind the “age in bonds” rule, which states that you own your age in risk-free investments, i.e. government bonds. For example, if you are 25 you should own 25% of your wealth in government bonds.

However, if you’re a 25-year-old who has higher risk appetite, the “age in bonds” rule can be modified to e.g. (age – 25)% in bonds. This slightly more complex rule states that the 25-year-old would have zero in government bonds, which would increases to 1% when he or she is 26 and so forth.

A 25-year-old who has no government bonds and puts all his or her wealth into, say, the stock market, has a high risk appetite, but more risk can be taken if he borrows to invest.

You don’t need to borrow to take on more risk

However, even if someone does no borrow, he can still take on more risk. This can be achieved by investing in internally leveraged ETFs (e.g. GEAR and GGUS) as well as investing in more risky investments, such as emerging markets (e.g. VGE), small caps (e.g. ISO), tech stocks (e.g. TECH and ROBO), and cryptocurrency (e.g. bitcoin, ether, or litecoin).

Right now bitcoin and cryptocurrencies in general are making headlines because of spectacular growth. Had you purchased $10k worth of bitcoin in 2013, you’d be a millionaire today. However, everyone knows that bitcoin and cryptocurrencies in general are risky, and when you hear stories about people borrowing money from their homes and putting it all into cryptocurrencies, most people think this is stupid. It is not that it is stupid but rather than their risk appetite is very high.

However, the example of leveraging into cryptocurrencies shows that you don’t need to borrow in order to gain access to high risk and potentially higher returns. If you simply invest in a riskier asset class, e.g. cryptocurrencies, you already increase risk and the potential for higher returns.

Debt is slavery – the psychological benefits of having no debt

I would argue that there is no need to borrow to increase risk and return because you can simply reallocate your money to risker assets (unless you believe that leveraging into bitcoin is not enough risk).

The benefits of having no debt goes far beyond the lower risk you’re exposed to. Debt is slavery. Happiness is an elusive goal. It is almost impossible for you to know what will make you happy in the future. You may think a particular job, relationship, car, holiday, or house will make you happy, but once you actually have it, you may not be happy. Trying to predict what will make you happy is hard, which is why the best way we humans can be happy to experiment and try out different things. In order to be able to try or experiment with different things that will make us happy, we must have the freedom to do so, and you don’t have that freedom if you’re forced to work in order to pay debt.

Even though freedom does not guarantee happiness, freedom is the best assurance we have of being happy.

Freedom comes from reducing your obligations. Obligations are mostly financial obligations (debt) but can be non-financial as well.

Ultimately it depends on your risk appetite

As I mentioned earlier, everyone has a different risk appetite. I have a fairly high risk appetite myself, but there are limits. For example, I’m happy to put 5% of my net worth into cryptocurrencies. I invest in certain sector ETFs because I estimate that they will outperform in the future (e.g. I am bullish on the tech sector).

Market fluctuations can result in the value of my ETFs and shares to go down by tens of thousands of dollars and I would sleep fine at night. However, there have been many times in my life when I have gotten carried away with buying too using my margin loan account and regretting it. You know you’re taken on too much risk when you worry about it.

Results don’t matter

The outcomes from investing are probabalistic, not deterministic, so results don’t matter. This is a common investing fallacy. Some guy would claim that he is worth $100 million due to borrowing money to generate wealth and that this is proof that you must use debt in order to become rich. However, this is misleading.

The outcomes from investing are probabalistic, not deterministic.

A person may borrow money to invest and be very successful, but another person may replicate the process, borrow to invest, and lose everything. What happens for one person may not necessarily happen for another person. For example, in 2013, there were many people who stripped money from their homes using home equity lines of credit and invested all that money into bitcoin. Just about everyone called these people stupid, but now they are multimillionaires. Does this mean you should borrow to invest in bitcoin right now? No. Just because bitcoin went up from 2013 to 2017 it doesn’t mean the same thing will happen e.g. from 2018 to 2020. Investing is not deterministic. Luck plays a major role.

Do you need debt?

Suppose you put 100% of your investments into risky areas such as cryptocurrencies, frontier market ETFs, mining stocks, etc. If you feel that this is not enough risk, borrowing to invest may be the answer, but I believe that most people do not want to take on this level of risk.

Where debt may be appropriate is if you having little savings and need to borrow money to invest in something that you are fairly certain is greater than the cost of borrowing, e.g. borrowing money for education and training can in most circumstances be a good idea. Even though borrowing money will cost you in interest, you boost your job prospects and your income. If you have savings (or if your parents have savings) then it is better to use those savings to educate or train yourself, but if you don’t have this, you need to go into debt as a necessary evil.

unsplash-logoAlice Pasqual

The Problem with Dividends #Podcast

Passive income is often considered a very important aspect of personal freedom and autonomy. An easy way to generate passive income is through dividend investing. However, while living off dividends is a great safety net to allow you to generate income without any work, there are two main problems, namely a lower capital gains and tax inefficiency.

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.

Agricultural Commodities Bottoming? ASX: QAG

The prices of agricultural commodities such as sugar, wheat, and soybeans have been falling for some time now. This can be seen in the performance of the QAG ETF.

For a number of months now I have been thinking that these commodities cannot go down forever. If this were the case, soybeans, sugar, etc would eventually be free. Could this be a buying opportunity?

QAG ASX price from 2012 to 2017
Source: Google