Returning to Living Off Dividends

There is a large body of personal finance advice that states that investing for dividends is unwise and tax inefficient. The argument is that when a company pays a dividend, the stock price must decline by the amount of the dividend to reflect the declining assets on the balance sheet. Hence receiving dividends is no different to simply selling shares except the difference is that the company makes the decision to sell rather than you. The argument goes that while you are working and earning a relatively high income, it is better to not receive dividends, which will be taxed heavily (because of your high income). It is better instead to let the earning accumulate as capital gains and then realise those gains after you retire when your income (and hence the tax bracket you’re in) drops.

About two or three years ago, I was strongly persuaded by these views (known as the dividend irrelevant theory). In a 2019 post titled My Changing Views, I said the following:

I believed that financial independence depended on dividends alone. If you generate high dividends, you will have enough to live off the dividends and become financially independent quickly. When I read back on my earlier posts (e.g. Dividends vs Capital Gains and 4% SWR vs Living off Dividends), I now notice that I seem quite cultish and stubborn in my views that dividends from Australian equities with franking credits was the only legitimate route to freedom and that anyone who does anything contrary to this is a slave! When I was in my twenties, I would dream of a life in my thirties, forties, and beyond flying around the world, relaxing on beaches, and living off dividends drinking coconut by the beach as I read books. Perhaps I am becoming more mature as I head into my mid-thirties. I have since relaxed my views on a pure Australian dividend focus. Even though I did invest in some foreign equities, I had the bulk of my investments in Australian equities, and one of the consequences of that is that capital gains were not as high. Had I invested in foreign equities, my net worth today would be much higher. Things may change in the future. I will not tinker too much with my portfolio. For all I know, the Australian stock market may perform very well, but what this illustrates is the importance of global diversification. Australia only makes up 2% of global equities, which is almost nothing, and you never know what policies may be implemented within a country that impacts on every single company in that country.

My scepticism of dividend investing and growing belief in the dividend irrelevance theory didn’t start in 2019. I had been thinking about it for a while. When I think about it today, I may have been strongly influenced by FOMO after seeing the performance of Australian equities (high dividends) relative to foreign equities (high growth). As a result, I did divert more money into foreign equities and even cryptocurrency. I also used my margin loan to leverage more into foreign equities.

Indeed, in the past few years, foreign equity and crypto (especially crypto) has outperformed Australian equity. In the past five years, Australian equity as represented by VAS went up 32% whereas foreign equity as represented by IWLD went up 58%. However, the total crypto market cap has gone up 20525% in the last five years.

Returning to living off dividends

Recently I have decided to shift my focus back to dividend investing. I have learned that going into debt and focusing on capital gains has some negative side effect.

I will not be selling my high growth and low yield investments (mostly foreign equity ETFs and crypto), but new money from my salary will now be invested into investments that pay high passive income e.g. Australian equity. (I am also looking into crypto staking as a way to earn passive income, but I am very new to this and that is a topic for another blog post.)

Sometimes it’s worth paying extra for professional service

According to the dividend irrelevance theory, receiving dividends is no different to selling shares except the company sells for you. In other words, the board of a company, a group of professionals, make the decision on how much earning to distribute to shareholders as dividends. Because professionals are making this decision, I like to use the term “professional dividends” as it contrasts with the term “homemade dividends.”

Homemade dividends refer to a form of investment income that investors generate from the sale of a percentage of their equity portfolio. The investor fulfills his cash flow objectives by selling a portion of shares in his portfolio instead of waiting for the traditional dividends. Usually, if a shareholder needs some cash inflow, but it is not yet time for a dividend payout, he can sell part of the shares in his portfolio to generate the required cash inflow.

Corporate Finance Institute

In my opinion, there is a benefit to relying on professionals to decide how much to spend and how much to reinvest. The 4% rule is a rule of thumb and is not perfect. It takes historic stock market performance in the US and assumes that what has happened in the past will likely happen in the future, but we don’t know if what has happened in the past can be extrapolated into the future. The high stock market returns of the past may have been fuelled by an abundance of natural resources, high fertility rate, and central bankers continually dropping interest rates. What happens now that natural resources are more scarce and the world faces climate change risk, low fertility rate, and interest rates dropping to near zero?

One of the principles of index investing is that you let the market decide rather than engage in “active investing.” The idea of letting an index weight companies by market capitalisation is that you have a higher exposure to companies that the market deems as better. In my opinion, the same idea applies to dividends. Generating homemade dividends seems like active investing. You are making very bold predictions about the sustainability of your wealth when using rules of thumb such as the 4% rule. By relying on the boards of multiple companies to decide the dividend payout ratio, you are crowd-sourcing what professionals and the market believe is an optimal amount of earnings to distribute as dividends. When boards make this decision, they are considering many factors such as risks they foresee in the future. When COVID-19 hit, many companies decided to reduce dividend payouts based on their judgements. Even if the judgment of these boards are not great, if a company pays out too much in dividends then the market should be able to detect this and reduce the share price, which, assuming you’re investing in a market cap weighted dividend ETF, means that your exposure to these types of companies is reduced.

We rely on professionals for many things in our lives e.g. accountants, lawyers, doctors, and even personal trainers. Often it is better to relying on professionals rather than do it yourself. The same idea applies to dividends.

Investing is emotional

One of the benefits of letting boards and professionals decide how much to distribute as dividends is that it takes out emotion. If you are generating your own homemade dividends by selling down stock, you will likely be overcome with emotions. If you sell too much, you might deplete your wealth before you die. If you sell too little, you will deprive yourself right now, and a stock market correction in the near future may wipe out all those gains anyway.

If you try to take away this emotion by relying on rules of thumb such as the 4% rule then you run the risk of being overly simplistic and extrapolating historical performance into the future. By outsourcing this decision to professionals and the market, you reduce emotion significantly.

When saving money, it is often advised that you should “pay yourself first” or “set and forget.” You should ideally automate everything so that you don’t need to think too much about it. Those who try to time the market tend to mess things up. The same logic applies to homemade dividends vs professional dividends. Living off dividends is automatic. Everything occurs in the background and you only see the dividends hitting your bank account.

A bird in hand is worth two in the bush

Another argument for dividend investing is that we do not know if a catastrophic market crash will hit us in the future. If we live off dividends rather than let those earnings compound on a company’s balance sheet, then certainly the growth of our net worth may be lower, but we spend more today, which can help address feelings of deprivation associated with aggressive frugality. If we focus entirely on capital gains, who is to say that just before we retire or during our retirement, an enormous market crash won’t wipe away everything? At least if we invest in high dividends and spend all our dividends, even if everything collapses near the end, we can look back and be happy that we lived off dividends.

The Downsides of Working from Home

I’ve done reasonably well out of COVID-19. Even though my net worth dropped back in March by about $120k, it has since recovered and grown much more rapidly than normal.

Working from home has saved me a lot of money e.g. I used to buy coffee and lunch every day when I was in the office, in addition to spending money on public transport, petrol, etc.

Even though I am saving and making a lot of money, I am somewhat keen to get back to the office. Working from home is mostly terrible.

My first gripe with working from home is OHS. My back is hurting. Ever since I started working from home, I have purchased a new desk, footrest and chair, but my back still hurts. Back in the office, someone else sets up my desk and made sure that it was ergonomic. With all the work I am doing at home, my back is really starting to hurt.

Another issue I have with working from home is that it is lonely and isolating. I miss socialising with people at work. I had a Zoom catch up with some coworkers about a week ago and we reminisced about some of the fun moments in the office, but when I thought about the last eight months working from home, nothing came to mind. It’s like I did nothing in the last eight months except work and sleep. There are no good memories. The thought that a person does nothing but stay in a small room all day by himself working, eating, watch Netflix, sleeping etc seems sad and dystopian.

Another problem with working from home is the drop in productivity. A lot of work gets done much slower when people are working from home. Simple work like writing a report or emailing can be done remotely very easily, but work that requires collaboration or quick exchange of ideas is difficult to pull off in a remote environment. Remote meetings are also really bad. When you are in the office and in a meeting, people are engaged, and I think this is because they know they are being watched, so they chip in and add value. However, in a remote meeting, the person who sets up the meeting really has to drive the meeting. Most people just turn off their video, mute themselves, and do something else e.g. check their e-mail. Workers seem to be more disengaged when working remotely.

Another reason why working from home is difficult is because the home can be a distracting place. I am somewhat lucky in that I don’t have children, so I am not interrupted much when I work, but many people do have children, and it definitely affects their productivity. Now that childcares have reopened, many parents are putting their children in childcare, but many parents do not, and due to their drop in productivity, a lot of work falls on other people.

Looking for Yield in Emerging Market Bonds (ASX: EBND)

I have finally sold HVST! For many years I have been holding onto this ETF, which has steadily gone down over many years (see The Problem with HVST). The reason why I was so reluctant to sell HVST was because it provided big juicy franked dividends paid monthly. As of today, HVST’s dividend yield is approximately 8 percent. Even though I enjoyed the high dividends, I was disgusted by the capital decline, so I made the decision to sell all my HVST.

Having sold HVST, I had spare cash which I was keen to reinvest. I decided to reinvest a portion of the cash into VanEck Emerging Income Opportunities Active ETF (EBND), an active ETF from Van Eck that invests in emerging market bonds.

What exactly are emerging market bonds? Basically you are lending money to the governments of poor countries. The average person might think this is financially reckless because of the credit risk of these government, but higher credit risk means higher yield. Investing in bonds of developed countries unfortunately means accepting very low yield (sometimes even negative yield). However, because these EM bonds are packaged in an ETF, you get significant diversification. You are not putting all your money into one country. In my opinion, investing in emerging market bonds is no more risky than investing in high dividend Australian equities.

Why invest in EBND?

The main reason I invested in EBND is because I wanted reliable and high monthly passive income. I was getting monthly passive income from HVST of about 8 percent. EBND provides monthly income as well, but its yield is approximately half that of HVST at about 5 percent. This might seem low, but the main benefit of EBND over HVST are capital gains or capital preservation.

EBND (blue) has outperformed HVST (red) during COVID-19

The chart above shows EBND (in blue) outperforming HVST (in red) during the COVID-19 crisis. I sold HVST in July 2020, so I wasn’t able to insulate myself from the COVID-19 crash of March 2020, but EBND would have provided no protection against this downturn anyway. In fact, as the chart above shows, EBND went down even more than HVST did. However, what EBND has been able to do was recover rapidly as central bankers around the world embarked on agressive money printing. In contrast, HVST has languished during the pandemic and continues to go down to this day.

What is surprising from the chart above is is how similar EM bonds are to global equities. The chart below compares EBND (blue) to global equities represented by VDHG (red) compared to DM bonds represented by VBND (green).

EBND (blue) is not a defenstive asset like VBND (green) is. In fact, EBND’s price chart somewhat resembles global equities as represented by VDHG (red).

The chart shows that EM bonds have a somewhat similar risk profile to global equities (with a beta of approximately 0.8). The chart also clearly shows that DM bonds are a much better defensive asset. The March 2020 COVID-19 crash resulted in large declines for EBND and VDHG of about 15 percent to 25 percent respectively but for VBND there were declines of only about 7 percent.

However, because I am still in my thirties and still consider myself somewhat young, I am comfortable taking more risk. Investing in EM bonds exposes me to equity-like risks while still providing high monthly income.

Another reason why I have invested in EBND is to diversify my sources of passive income away from Australian equities. A big problem with relying on Australian equities for income is concentration risk. The ASX 200 is dominated by a handful of banks and miners. If anything happens that significantly affects these businesses, your dividends are under threat. We are seeing this today as Australian banks cut dividends due to the impact of COVID-19. While I still hold a reasonable amount of high dividend Australian equity ETFs (e.g. through IHD and SYI), I am keen to spread my passive income sources to other areas in order to reduce risk. Having sold a large amount of HVST, I am keen not to reinvest the proceeds back into Australian equities which would only exacerbate my concentration risk.

EBND vs IHEB

Those who keenly follow the ASX ETF scene may understand that EBND is not the only EM bond ETF on the ASX. In fact, an investor can invest in EM bonds through the iShares J.P. Morgan USD Emerging Markets Bond (AUD Hedged) ETF (IHEB).

The benefit of IHEB over EBND is that is has a much lower management fee of 0.51% rather than EBND’s pricey 0.95 percent. This is due to the fact that IHEB is a passive index fund vs EBND which is actively managed.

While EBND pays monthly income, IHEB pays income tri-annually. Both seem to have roughly similar yields of about 5 percent, although EBND’s distributions seem more consistent and smooth.

Another major difference between EBND and IHEB comes from currency and particularly the US dollar. IHEB invests only in US dollar denominated bonds. This means it invests in debt from countries that borrow in US dollars. What this means is that if the US dollar goes up in value, the debt of these governments rise. This makes IHEB highly sensitive to the US dollar. IHEB will perform better the weaker the US dollar is. Add to that the fact that IHEB is AUD hedged, which means that as the US dollar weakens, IHEB will go up even more. In contrast, all currency considerations in EBND are at the discretion of the fund managers. The fund manager could invest in US dollar denominated EM bonds, but they can also invest in EM bonds denominated in the country’s local currency.

EBND (blue) vs IHEB (orange) vs DXY (purple)

The chart above shows EBND (blue) vs IHEB (orange) vs the US dollar index DXY (purple). About half of all debt in the world is denominated in US dollars. A considerable amount of investors borrow in US dollars (low yield) and invest in emerging markets where yields and risk are higher. However, borrowing to invest is extremely risky. You amplify your gains but also amplify any losses, which is why many investors who leverage are keen to sell during times of crisis. For example, during e.g. the March 2020 COVID-19 crash, when asset prices were collapsing, many investors sold down assets. They do this either because they wish to sell assets themselves before prices go down even further or perhaps they are forced to sell by their banks as margin calls are triggered. Regardless, because they borrowed in US dollars, when they sell assets, they get US dollars in return, which increases the demand for US dollars. This explains the spike in DXY in purple during the March COVID-19 crash.

As the chart shows, IHEB collapsed as DXY spiked, which makes sense. However, during the COVID-19 recovery, IHEB recovered rapidly as central banks aggressively printed money and devalued the US dollar. EBND is much less senstive to USD currency fluctuations.

The tables below also show that the countries that IHEB invests in (right) seem different to those that EBND (left) invest in. Generally speaking, resource rich countries (e.g. Saudi Arabia, Qatar, UAE, Russia, and Brazil) seem to have more US dollar denominated debt.

Problems with EBND

As mentioned above, high management fees of 0.95% are a big problem with EBND. Over time, these fees will compound, eating away into returns. Another downside for EBND is active management, although some argue that active management is beneficial in emerging markets where human discretion matters more.

The opportunity of emerging markets in general

I am investing in EM bonds for income, but I am also investing more and more into EM equities as well (via IEM). Global macro investor Raoul Pal has recently tweeted a chart of the EM equities to S&P 500 ratio, which suggests that EM equities are highly undervalued and may turn any moment now to the upside.

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EM equities to S&P 500 ratio. Source: Raoul Pal

I also think that many people overestimate the risk of emerging market bonds and emerging markets in general. Most people think of EM countries as backwards and corrupt, places where money cannot be made. But this is simply not true, and the fact that people believe this I think means that EM is undervalued relative to DM, which is bullish for EM.

EM countries have very favourable demographics i.e. higher population growth and a much younger population. They also have a strong appetite for economic growth and development. As a world traveller, I’ve been to many of the “megacities” (urban population > 20 million) of the world today (e.g. Shanghai, Chongqing, Mumbai, Delhi, Sao Paulo, Jakarta, Dhaka, and even Lagos), and when I explore these cities, I get a strong sense of how dynamic these places are and how much pent-up economic growth they hold.

In my opinion, the only downside to emerging market investments are ethical concerns. If you lend to e.g. the Chinese or Indian governments, are you contributing to the oppression of Uighurs in China or Kashmiris in India? There is a question mark on the ESG credentials of these investments. On one hand, developed markets tend to have more political freedoms and e.g. greener policies, but on the other hand, if you don’t invest in emerging markets, they will remain poor, which is not ethical.

Living off Dividends vs the Four Percent Rule – Part 2

According to Wikipedia, financial independence is defined as “the status of having enough income to pay for one’s reasonable living expenses for the rest of one’s life without having to rely on formal employment.”

Financial independence does not mean you have e.g. a late-model luxury car, an expensive house, a nice watch, or even a paid-off house. If you have to work, you’re not financially independent because you are dependent on your job.

So how do you live off your investments forever? There are two main ways to achieve this: (1) live off dividends and (2) sell assets according to the “four percent rule.”

In a post I made back in 2018 titled 4% Safe Withdrawal Rate vs Living off Dividends, I claim that it is better to live off dividends because it is easier:

 [It] is better in my opinion to simply live off your investment income (dividends, rent, interest, etc) as there is no calculation involved and no work. Everything is on autopilot. That being said when living off dividends there is a trade off between income and growth (see The Problem with HVST) and this is where I think the four percent rule can be used as a guide. If your dividend income is more than 4% of your net worth, invest more in growth assets whereas if your dividend income is less than 4% of your net worth, invest in income-producing assets.

Living off dividends is indeed simple. Suppose you have $1 million. You invest it in a high dividend ETF (e.g. IHD, SYI or VHY) and that is it. The dividends will be paid to your bank account, which you live off.

However, there are many problems with relying on dividends. Typically Australian investors have relied on blue chip Australian stocks for dividends because of favourable tax treatment (due to franking credits). The problem is that these stocks tend to be concentrated among a handful of companies and historically Australian high dividend payers have performed poorly. It makes sense that high dividend paying stocks underperform because each dollar paid out in dividends is a dollar not reinvested in the company. Because the company pays out the profit as dividends, it is not able to use that money to further grow the company. The chart below demonstrates the underperformance of high dividend paying stocks by comparing an Australian high dividend ETF (black) with the broader Australian equity market (orange). For the sake of comparison, the Nasdaq 100 is represented in blue, which is the NDQ ETF tracking an index that consists mostly of technology companies that historically pay low dividends but instead reinvest profits for growth. Major companies in NDQ are Amazon, Microsoft, Apple, Google, Facebook, etc.

High dividend ETF IHD (in black) underperforms the broader Australian stock market (represented by STW in orange) and significantly underperforms the tech-heavy Nasdaq 100 index (represented by NDQ in blue). Source: Bloomberg

In contrast to the simplicity of dividends, implementing the four percent rule is more difficult, but there is considerable evidence that this approach is better, not only due to it being more tax efficient but also because the assets you invest in tend to earn more (as demonstrated in the above chart comparing the Nasdaq 100 ETF vs an Australian high dividend index ETF). Suppose you have $1 million. Rather than invest this in high dividend stocks or ETFs, you invest it in high growth stocks or ETFs that focus more on capital gains rather than dividends. You can choose NDQ, a Nasdaq 100 ETF, but if you want more diversification across countries and sectors, a good high growth ETF is VDHG, which invests in 90% global equities and 10% bonds. (Another ETF similar to VDHG but with slightly lower fees is DHHF.)

How to implement the 4% rule

When you retire, rather than rely on dividends, you simply sell off 4% of the value of the investments each year, so if you have $1 million you sell off $40k and then live off that for the first year. The expectation is that after you sell $40k then you will have $960k, but if we assume 7% annual growth then the next year your net worth will grow to $1.027 million and then you withdraw 4% of this, which is $41,088. This higher withdrawal in the next year accounts for inflation. (Note there is some uncertainty about whether, in this example of retiring with $1 million, you simply withdraw $40k each year or if you withdraw 4% of the new balance each year. I believe the latter option is safer because it explicitly accounts for inflation.)

The “four percent rule” is controversial with many arguing that it is only designed to last you thirty years. However, a simple fix to this problem is to withdraw 3% of your portfolio each year rather than 4% and, in my opinion, anything below 3% is far too conservative. Based on FireCalc.com, although the 4% rule fails with 95% probability after 30 years, the 3% rule is highly likely to last you forever. Basically if you are retiring in your 60s or 70s, you should be able to get away with the 4% rule, but if you retire any earlier, you should use the 3% rule instead.

The chart below made using FireCalc.com provides a simulation of historic stock market returns using the 4% rule and shows that over 70 years there is a good change you will not run out of money after 70 years but there is approximately a 10% probaility that you will (represented by lines going down below the horizontal red line).

Simulation showing the 4% withdrawal rate has an approximately 10% probability of failure over 70 years. Source: FireCalc.com

However, using the 3% rule, there are no probability where you lose your money (based on historic stock market performance), even under the assumption that you retire in your 30s and live for 70 years.

Simulation showing a 3% withdrawl rate being highly likely to last you forever. Source: FireCalc.com

The reason why selling off assets is more tax efficient is because capital gains are not realised until you sell the assets, which means you can sell them when you retire. By selling off assets when you retire, you do so when your income is low, which exposes more of your capital gains to low (or zero) income tax brackets. However, dividends are taxed once they are paid, which means that while you are working and accumulating assets, you’ll pay taxes on dividend income while your income is relatively high.

Capital gains are subject to Australian income tax rates once the capital gains are realised.

What will I do?

Early in my journey towards financial independence, I focused mainly on accumulating high dividend ETFs e.g. IHD and even HVST (see The Problem with HVST). When investing in purely Australian equities, I discovered that not only did my investments underperform but I also needed to pay taxes every year. To address this problem, I used a margin loan to borrow against my ETFs and diversify into international and emerging market equities more (e.g. I made some good bets on technology ETFs). Having a margin loan has its pros and cons, but one of the pros is that the interest on the margin loan is tax deductible, which helps to offset the tax paid on the dividends from Australian equities. Today Australian equities make up approximately half of my equities with the other half in international equities and a small amount of emerging market equities. Although I have a margin loan, I have started dabbling in NAB Equity Builder. NAB EB allows you to borrow at a lower rate compared to a margin loan.

While I am moving towards growth rather than dividends, I am still holding onto my high dividend ETFs. My plan is, rather than choose between dividends or growth, I will simply aim for both. There are many benefits of dividend investing e.g. franking credits. Furhermore, even though Australian high dividend stocks have underperformed in the last decade, there may be hope in the future as these companies enter the post-COVID future. If I sell Australian dividend stocks and use the proceeds to purchase global tech stocks, there is a very real risk that I will sell low and buy high, so rather than sell, I prefer to simply leave my Australian dividend stocks and ETFs. It should also be noted that there are other ETFs on the ASX that pay high dividends but do not invest in Australian equities e.g. UMAX uses options against the S&P500 to generate income; EBND invests in emerging market bonds and pays approximately 5% monthly; and TECH focuses on global tech stocks that have strong moats, and surprisingly this ETF has a dividend yield of approximately 9% paid yearly. I will discuss these non-Australian high-yield ETFs in a separate future blog post.

Property vs shares

Although it is clear that I have a bias towards shares over property, the strategy of selling down high growth ETFs exposes yet another benefit of shares vs property, which is the ability of ETFs to be sold in small chunks. If you have a $1 million property, you cannot sell half of it because no one will want half a property. You must sell it all in one go. Suppose you make $500k capital gains. Then $18200 of that will be exempt from tax while the rest of it is subject to tax, so you’ve managed to avoid tax on $18200. Now suppose you have $1 million in ETFs, which we will assume is $1 million all in VDHG. Rather then being forced to sell all of it in one go, you sell half of it in one year and the other half the next year. By doing this you realise $250k in each year. This exposes $36400 to the tax free threshold. By being able to sell smaller portions, you make the most of the tax free threshold.

Thanks to ETFs being highly divisible, I can sell off small amounts of ETFs each year thereby spreading capital gains across multiple years and exposing more capital gains to low tax brackets. Furthermore, any capital gains on assets held over one year receive a 50% CGT discount.

Another benefit of investing in ETFs rather than property is that you can sell ETFs cheaply e.g. selling one property will cost you about $20k to $30k in real estate agent commissions, but with ETFs you will pay about $20 or $30 to sell (or even $9.50 for discount online broker SelfWealth).

Other benefits of ETFs vs property is you avoid stamp duty and land tax. You also have access to franking credits.

Of course, in all fairness, there are some downsides of ETFs vs property e.g. the interest rate on NAB EB and margin loans are higher than those on mortgages, and although you can achieve leverage of about 70% using NAB EB or margin loans, you are able to achieve leverage of 80% up to 95% with property. In my opinion, even if you are able to achieve more leverage against property, it doesn’t necessarily mean you should. Leverage can magnify gains but also magnifies losses should the market go through a downturn. When leveraging into ETFs, you are able to diversify within the portfolio defensive assets such as bond ETFs (e.g. VDCO), hybrid ETFs (e.g. HBRD) or even gold mining ETFs (e.g. GDX), which reduces volatility. When you leverage into a property, you are all in one property in one place, exposed to an universified asset in one location. Many believe that property is safe compared to the volatility of the stock market, but if you invest in a highly diversified ETF, it is safer than investing in one property. The lack of volatility in property is actually the result of poor price discovery mechanisms rather than because property is inherently safer than shares. Once property is listed and exposed to the same price discovery mechanism of shares, property is highly volatile as evidenced by the price charts of residential REITs.

Disclosure: I own IHD, SYI, HVST, NDQ, UMAX, EBND, TECH, HBRD, and GDX.

More Thoughts on Remote Working during the COVID-19 Crisis

It has been a few months since the COVID-19 crisis has hit, and as a result of this crisis, I have settled into working from home. I’d like to describe my experience working from home from my parents’ home for the last few months.

Disadvantages of remote work

First of all, I find I have been quite busy. I would often either wake up early or work into the night in order to get work done. It seems there is more work to do when working from home. There are definitely advantages of working from home, but there are definitely disadvantages, the main disadvantage being that it is more difficult to work with others. For example, when you’re in an office, you can walk to someone’s desk and talk to them about something, but in a remote environment, you need to e-mail or call them, and they may not respond to your e-mails or calls. Furthermore, when I am in the office, I can walk to someone’s desk. If they are on the phone, it is clear they are busy, so I can walk away and come back at another time. However, when working remotely, I am more reluctant to ring someone because I have no idea what they are doing. They might be in the toilet or they might be changing their baby’s nappies, so there is this fear that I may intrude on their private lives whereas at work the expectation is that you work at work so you have no private life at work. Working from home does not seem to work well for “fast-paced” work where quick communication is necessary, especially when there is a deadline looming.

Advantages of remote work

There are advantages of remote work. In my opinion, there are more advantages than disadvantages. If I had to choose between working at home or working at the office, I’d prefer working at home, but ideally I’d prefer to have both options. There are some tasks I’d prefer to ask colleagues to come into the office to do, and there is also better socialisation in the office. For those who do live by themselves or who do not have too many friends outside of work, the office becomes the source of friend and family.

For me, the key benefit of working from home is I save a considerable amount of time not commuting. You don’t need to drive or take a train to work, which benefits me greatly because it takes one hour for me to get to work, which means I get two extra hours per day to sleep, exercise, read or watch Netflix. Another benefit is that you don’t need to worry about what you wear. When you go into the office, you need to dress correctly. However, when you work from home, you can wear anything. You can just put on sweatpants and a hoodie or you can stay in your pajamas. Even if you are on a Zoom call, you can turn off the video or you can position the camera so your clothes are off the screen.

Another benefit of working from home is that you don’t need to concentrate in meetings. This might sounds bad, but there are many meetings where you can safely turn off video and audio and do your other work. You can dedicate half your attention listening to the meeting (in case you need to speak) and the other half doing your other work.

Something I have noticed ever since working from home is that I am signing up to many webinars. Back in the office there are plenty of optional training sessions that I do not sign up for because I simply don’t have time. If I needed to get off my desk to go to one hour of training, that is one hour I would not be working. I only go to those training sessions that are mandatory. However, since all these training sessions are now online, they are quick and easy to sign up for, you can listen to them while doing your other work, and if something urgent comes up at work, you can simply and easily leave the webinar without any embarrassment or shame. As a result, I have gone to many webinars and feel I have learned a considerable amount about many different topics, from HR all the way to finance, retirement planning, etc.

Another benefit of the COVID-19 crisis is the amount of money I have saved. I don’t drive much, but in the last three months I have not driven at all, so I have saved a lot of money on petrol. Even when I have the option to drive short distances, I prefer to walk instead because I spend so much time indoors that I want to walk more to be outdoors. (When you drive, you are indoors.) I also never eat out, go to cafes, etc. Any socialising needs to be online, so it is free. I watch Netflix rather than go to the cinemas. Basically everything is done at home or online, which is much cheaper than “going out.”

I am still working from home and I have no idea when I will be going back to the office. I have heard that many organisations have asked their workers to come back whereas others are providing staff with the option to work from home or not. In my opinion, the best approach is to permanently give staff freedom to work from home or come into the office, which is what Twitter has done.

Impact on the property market

The impact of COVID-19 on the property market is very unclear. There is a considerable amount of stimulus being applied to prop up not just the property market but also the stock market. That being said, if remote working becomes the norm, there is no advantage of working near the city anymore. This means I can live in the outer suburbs without worrying. Even if it takes me two hours to commute into the city, if I do so rarely, it’s not a problem. This means the cost of putting a roof over your head goes down considerably. It costs about $1600 per month to rent a one-bedroom apartment in the city, but in the outskirts of the city it costs about $1000 per month, so automatically you save $600 per month. Using the 4% rule, this means you only need to save $300k to pay rent forever (rather than $480k).

The frugal non-consumerist post-COVID lifestyle

Based on quick calculations for a single childfree person living in an Australian city, COVID-19 has reduced the cost of living by about one-third, from $3500 per month to about $2111 per month. Once again, using the 4% rule, this means you only need about $633k to retire rather than $1 million.

How is this possible? Because you no longer need to live near work, you can minimise costs by moving to the outskirts of the city, which should halve your rent. I am assuming the cost of a one-bedroom apartment in Melbourne CBD vs a one-bedroom unit in the outskirts of Melbourne (e.g. Frankston). Because you are not going out at all but eating at home all the time, this should halve your food costs. You also don’t need a car because you can walk, bike or take public transport everywhere. Assuming all other expenses stay the same, this cuts costs by about one-third.

Expense ItemMonthly Post-COVID CostMonthly Pre-COVID Cost
Rent$1000 $2000
Food$311 $600
Car$100
Other$800 $800
Total$2111 $3500
Estimated monthly cost of living pre-COVID and post-COVID. “Other” includes electricity, internet, streaming services, etc.

In my opinion, one of the benefits of the COVID crisis is that it has forced people to live a non-consumerist lifestyle, which may result in many people realising that they are able to retire early if they want to. You don’t necessarily need $1 million to retire because living in isolation has taught you that you only need about $650k to retire.

In my opinion, a post-COVID lifestyle presents an opportunity to live more environmentally sustainably. A lifestyle with less car use, less overseas travel, less “going out” and more bike riding, walking, having meetings online, etc are better for the environment. I also think that caring for the environment can help you save more money because it provides extra motivation. For example, I am driving less today not only because I save money driving less but also because I am starting to feel very guilty driving a car. This extra guilt helps to discourage me from driving or travelling or going out to restaurants.

What about the economy and personal finances?

There is a considerable amount of uncertainty about the future of the economy. Some believe there will be a V-shaped recovery whereas others are expecting a W-shape or even an L-shape. Regardless of what letter of the alphabet the stock market resembles, I am not too concerned because I have diversified my portfolio to include not just equities but also bonds, gold and even cryptocurrency.

Another benefit of the COVID crisis is that interest rates have fallen. The interest rates on my CommSec margin loan as well as NAB Equity Builder have both fallen (5.6% and 3.9% respectively). As I have explained in other posts, debt can be positive because you are able to deduct interest expenses. Many people invest with debt when buying a property, and they deduct interest expenses. It is possible to do the same with ETFs, but in my opinion the main benefit of holding debt to buy shares rather than property is that stocks or ETFs can quickly and cheaply be sold to extinguish the debt whereas a property is very expensive to sell. For example, if I borrowed money to buy ETFs and suddenly wanted to retire early, I can sell ETFs and with the proceeds I can pay off all my debt. However, if I borrowed to buy a property and suddenly wanted to retire, selling a property to extinguish the debt would cost me about $30k in real estate agent commission.

Another benefit of ETFs vs property is that you can avoid or minimise capital gains tax. If you own an investment property with debt on it and you suddenly retire, you need to sell it to pay off the debt. Selling it will trigger capital gains tax. For example, suppose you buy a property for $500k and it increases in price to $1 million. Then you sell it but need to pay CGT on the $500k price rise. However, the benefit of ETFs is that you don’t have to sell all ETFs at once. Suppose you purchase $500k in ETFs and it rises to $1 million in price. Rather than sell all the ETFs, you only sell half thereby realising only $250k in capital gains. Then you sell the other half the next year thereby maximising the amount of capital gains subject to lower income tax rates. This works in Australia because capital gains tax is based on the progressive income tax rates. Under the Australian income tax system, income (including triggered capital gains) under $18200 in the financial year is exempt from any tax whereas any amount above that is subject to tax. So if you sell a property and realise $500k capital gains, then only $18.2k of that is exempt from tax with the rest being subject to tax. But if you sell half your ETFs in one year and the other half the next year, then $36.4k is exempt from tax. ETFs are highly divisible, which allows this, but property is not. You cannot sell half the house and then the other half the next year.

Because I have invested in a range of different ETFs, if I needed to retire quickly and needed to extinguish the debt, I would simply sell an ETF that has made large gains and then offset these gains by selling off a different ETF that has made losses. The losses and the gains would roughly cancel each other out, which means there is little capital gains tax to pay. Any existing capital gains can be left untriggered. ETFs allow you to control your capital gains and therefore your capital gains tax.

Some people say that an easy way to avoid CGT is to put your money into your principal property of residence (PPOR), which is exempt from CGT. However, this does not work. When people buy an property, there is a reason why investors prefer to put a tenant into it even if doing so removes CGT exemption. It is because putting a tenant into a property provides the landlord with rental income as well as the ability to deduct expenses. The gains from the rental income and interest deductions is greater than the loss of CGT exemption. If this were not the case, there would be no investment properties because landlord would put any extra money into their main residence rather than invest it in a rental property. This means it would be impossible to rent because no landlord would put money into rental properties because the tax advantages would be greater for main residence. The government must provide rental property investors greater tax benefits for rental property compared to main residences otherwise the rental market would not exist. That rental income and tax deduction on expenses from owning investments is greater than CGT exemption on a PPOR is the key factor that justifies “rentvesting” but that is a topic for a separate future post.

Am I close to retirement?

There are two main reasons why I would feel uncomfortable retiring today. One is that I have quite a bit of debt. Of course, I can sell assets to pay off the debt, and some of my investment income can be used to meet the debt repayments. However, I feel reluctant to do this. Part of me feels that I should pay off more debt or at least generate more dividend income to meet all debt obligations.

Another reason why I am reluctant to retire is because a substantial amount of my personal wealth is in my superannuation fund, which I don’t have access to until I am 60. This means that if I retire now, I will need to implement the “two bucket system” and run down my non-super bucket that will tide me over until I have access to my super, which will help me pay off my debts. If I implement the “two bucket system” right now, I’d be living a very frugal lifestyle with a pre-super safe withdrawal rate of about 2 per cent rather than 4 per cent. I want to build up more wealth in my non-super bucket that will tide me over until 60.

New podcasts and website

While under lockdown, I have been listening to many podcasts. A recent podcast that I highly recommend is FIRE and Chill which discusses personal finance in Australia.

Another website that I find useful is the Nomadlist FIRE calculator, which helps you determine which countries you are able to retire in based on your net worth. The most expensive city to live in is New York, so if you have enough net worth to be able to retire in New York (about US$1.1 million), in my opinion you are effectively financially independent. However, what this site teaches you is that even if you have low net worth, there are many countries all around the world where the cost of living is low, which means you will be able to retire very quickly. Many people assume that they need to live in expensive cities e.g. Sydney, Melbourne, New York, London, etc. However, the world is enormous and there are so many places where it is cheap to live. For example, in Liverpool, UK you can live off US$500k. In Davao, Phillipines you can live off US$250k. Looking at sites like this is a strong motivator because as my net worth grows, I am able to tick off cities around the world where I am able to live. The ultimate achievement is ticking off on New York because then you’d have the safety and security of knowing you can retire early in the world’s most expensive city.

The Impact of Coronavirus on Financial Independence

The stock market crash caused by the Coronavirus (COVID-19) has hit hard. Top to bottom, the ASX 200 has fallen about 30% and we don’t know if it will continue to fall. What I found incredible about this downturn is how fast it was. The GFC back in 2008 was a much more staggered downturn whereas the COVID-19 crash looks like a straight line down.

The only way to prevent the spread of this virus is to restrict movement. However, restricting movement hurts the economy. If people cannot commute to work, travel to another country to do a business deal, go to a shop to buy something, etc then trade doesn’t happen. If trade doesn’t happen, businesses collapse. This may lead to businesses firing staff, which reduces spending, which leads to more business collapse.

Diversification

This whole incident demonstrates the importance of diversification. Even though I am heavily invested in high-dividend Australian equities, the risk with focusing on a narrow asset class is a lack of diversification, so my focus on high-dividend Australian equities has definitely not helped me during this market crash.

The video above (with overly dramatic music) demonstrates how widely different countries’ stock markets have performed during the virus outbreak and illustrates the importance of diversification. Chinese equities have held up very well compared to the stock indices of other countries. Other assets that have held up well are gold, government bonds, and the US dollar.

All this demonstrates the importance of diversifying across a range of different assets. Because a significant amount of my wealth is in high-dividend paying Australian equities (e.g. IHD), I have made significant six-digit losses. Investing with leverage doesn’t help either. Nevertheless, I am relatively young and feel hopeful that there will be a recovery. As I get older, I will definitely reduce risk by diversifying into a variety of safe haven assets, but while I am young I do feel an obligation to invest in riskier and more volatile assets.

Mass job losses as a result of COVID-19

Something else that the COVID-19 crash demonstrates is the importance of financial independence. Being able to live off your investments forever is important because your job is not certain. Many people have an optimism bias and think they will be employed forever, and they structure their life around the assumption that they will always be employed. However, even what is perceived to be a safe job can be unsafe. For example, a pilot may think their job is bulletproof. They may think that air travel will always happen, so their job is safe. Black swan events do happen.

In my opinion, you should aim to be financially independent as fast as possible, as soon as you leave school or university. This involves a combination of high savings as well as cutting costs of living. If you are able to live off $10k per year, you only need to save $250k in order to retire (according to the four percent rule). If, when you are young, you inflate your lifestyle to $40k per year in expenses, you will need to save $1 million. The better you are at being content with living on little, the quicker it will be for you to be financially independent.

Surviving self-isolation

As a result of Covid-19, I am now working at home. I find there are pros and cons to working from home, but I am getting used to it. The biggest pro is being able to wake up about one to two hours later because I no longer need to get dressed or take the train into the city. Although not essential, I feel it is good to start the day by having a shower, wearing reasonably nice clothes (so you look okay when video-conferencing), and having a coffee. Not only is being clean, neat, and caffeinated important in itself, but the ritual of these activities helps to put your mind into “work mode.”

I have been to the supermarket in these new times, but it is not a pleasant experience. Everyone seems nervous and anxious. They stare at you as if you are going to grab the last pack of toilet paper. There are many stories of shoppers fighting over toilet paper, which I think is disappointing. To avoid crazy people and to avoid being infected, as much as possible, I am trying to avoid going to the supermarkets by buying essentials online. Many essentials can be purchased online, from food to toilet paper. Hoarding toilet paper, in my opinion, is not a good idea because toilet paper prices are high now, so you should only buy what you need and put any excess cash into the stock market.

The key to surviving Covid-19 is to have good respiratory health and a strong immune system, which is why exercise is important. Even though the government has imposed restrictions, exercise is still allowed where I live, so I make sure I ride my bike around the neighbourhood regularly. Riding a bike is not just a form of exercise but is also a cheap way to commute. Surprisingly, the park trails are filled with people walking their dogs, so I find that it is safer to ride on the roads where there are almost no cars.

While the global community deals with Covid-19, what is becoming clear is that many of those who contract the virus have no symptoms or mild symptoms and are able to make a strong recovery thanks to a strong immune system. As such, I have been trying to eat as much fruit and vegetables as possible.

Now is the time to dollar cost average into the stock market

I have heard of many people selling shares or converting their superannuation into 100% cash. The Australian government will soon allow those who are affected by Covid-19 to access $10k from their superannuation. This is a bad idea. Now is the time to be buying stocks, not selling.

“The best time to buy is when there is blood on the streets, even if the blood is your own.” Baron Rothschild

Will Australian property prices go down?

It makes sense that property prices are not immune from Covid-19. If enough people are unemployed from Covid-19, they will not be able to meet their mortgage obligations nor will they be able to save for a deposit on a property. Property investors typically rely on tenants to pay them rent so they can meet their own mortgage obligations, so if tenants lose their jobs, landlords may be required to sell their properties. Falling demand and rising supply push prices down.

However, there are a number of policies put in place that can prop up property prices e.g. lower interest rates and six-month mortgage holidays. These measures put in place to stimulate the property market, in my opinion, are good reasons why you should not buy a property now. Because the stock market has fallen so violently, the prices for these assets are very attractive relative to historical earnings (and dividends) whereas if property prices are propped up, you are not getting any discount on your purchases relative to rental income. The cheaper you buy your investments relative to income, the more they will go up when there is a recovery.

The silver lining

Although the Covid-19 outbreak has caused considerable wealth destuction and job losses, there is a silver lining. One benefit is that carbon emissions are falling sharply across the world, but unfortunately when the recovery happens, all this may be reversed. Another benefit of Covid-19 is that remote working systems across the world will be strengthened, which means over time more and more workers can work either fully remote or partially remote. This means I may be able to pursue my dream of becoming a “digital nomad” while still doing the 9-5 job I am familiar with. Usually those who work remotely are people with families, tech workers, graphic designers, etc, but the Covid-19 outbreak will normalise remote work for everyone because it has forced everyone to work from home (unless the job cannot be done at home). This is good not just because it means you don’t need to commute but it also means you can potentially travel while you work or work from low-cost-of-living countries. A world of remote work could look very different to the sort of world we live in today which is build upon the idea that you live in the suburbs, commute into the city every day, and take an overseas holiday two weeks per year. If more and more work is remote, we may see permanent digital nomads i.e. rather than commute for hours each day on the freeway or a train and get two weeks per year of travel, you can travel permanently, be on “permanent vacation,” hopping from one country to another and living and working in co-living spaces. This is all very utopian but it may be a reality, and even if it is not a lifestyle most people embrace in the future, it is certainly a lifestyle you can design for yourself once you are financially independent.