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
MONYUBS IQ Cash ETFLow
BILLiShares Core Cash ETFLow

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

The Simplicity of Living off Dividends

Some people have made comments that many of my posts on this blog are not finance related, so I will make an effort to post more about ETFs and other financial topics in the future. Perhaps the reason why there are few finance topics on this blog is because living off dividends is such a simple technique that I rarely think too much about finance. The whole point of making money is so you do not need to think about money. You do not need to stress about making ends meet when you have few obligations and multiple streams of dividends flowing into your bank account.

Budgeting, tracking net worth, trading, and rebalancing are not worth it

While most people maintain spreadsheets to track expenses and net worth, living off dividends only requires you to invest all your work salary and spend your dividends. If you end up spending more than dividend income, simply “borrow from yourself” by maintaining a few thousand dollars in cash in a separate savings account that you borrow from but pay back with dividend income. Either use a spreadsheet to keep track of how much you own to yourself or ensure that this savings account has a fixed amount e.g. you have $2000 in it, run out of dividends to spend, so you “borrow” $500 to have a balance of $1500 and then when your next dividend payment comes in, put $500 into this savings account to top it back up to $2000.

I don’t recommend tracking your expenses or tracking your net worth because it is time consuming and because the information you get out of it is not valuable. If you track expenses, you can see where all your spending goes, but what matters is not what you spend your money on but how much you spend. If you spend such that your expenses are equal to dividend income, this ensures you don’t spend too much, and one of the benefits of living off dividends is that dividends increase over time as you invest more and as companies become more profitable, so there is a gradual increase in standard of living, which I think helps overcome the feeling of deprivation many feel when they are frugal. If you only spend e.g. $10,000 per year for the rest of your life, you are stuck on that level and do not feel as if you are growing or making progress, but if you live off dividends and your dividends grow, you feel a sense of personal growth. As for tracking net worth, when you diversify across multiple areas (e.g. retirement accounts, managed funds, ETFs, cryptocurrency, etc) then it becomes a huge burden to log in to each of these accounts to check the balance. What matters to financial independence is not net worth per se but passive income. You live off passive income, not net worth, and if you live off passive income then you’ll be able to assess automatically whether you have enough based on whether you are satisfied or not with your standard of living.

Because living off dividends is simple, there are only two things you need to consider: how to spend your dividends and what to invest your work salary in. Most people have no issue with figuring out how to spend their money (e.g. holidays, books, smartphones, and coffee). What to invest in is more complicated, and generally I recommend buying broad and diversified ETFs with a slightly heavier allocation towards high dividend paying ETFs (or LICs). However, more important than what you invest in, in my opinion, is the “buy and hold” mentality. You should buy with the intention of holding these investments for a long time, if not forever. I also do not bother with rebalancing. For example, in recent years the Australian stock market has underperformed whereas foreign stocks (particularly US stocks) have done very well. There are those who rebalance by selling off US stocks to buy Australia stocks to maintain a certain amount to certain countries. This is far more effort than necessary, adds administrative burden by triggering capital gains tax, and does not add much value because if you feel you have too little Australian stock, rather than sell US stock, you can simply buy more Australian stocks. For example, in recent years, as US equities has gone up, I have purchased more high-dividend paying Australian stocks and ETFs e.g. CBA and IHD.

Age in VDCO

For most people who ask, I recommend Vanguard’s diversified ETFs. You cannot beat the simplicity of these ETFs. Whatever your age is, hold that amount in VDCO and the rest you hold in VDHG. For example, if you’re 30 then hold 30% VDCO and 70% VDHG. These Vanguard diversified ETFs diversify across just about all asset classes (e.g. Australian shares, international shares, emerging markets, small caps, property, bonds, etc) so you don’t need to worry about mixing and matching. The reason why you hold your age in VDCO is to broadly follow the “age in bonds” rule, which is insurance against retiring just after a huge market crash. There are many people who are anti-bond and claim that they are a drag on performance, that stocks always go up on the long run, etc, but this is not true. In fact, this is dangerous advice. There is no guarantee that stocks go up in the long run as the value of stocks merely represent company profits and there is no guarantee that company profits will go up in the long run. Even if stocks do go up in the long run, there are huge market crash (e.g. 50% decline) that emerge, not just normal business cycles but debt supercycles that can take centuries to materialize. You do not want to be in the position of being in 100% equities and then losing 50% just before you retire as this can really set you back and impact on the quality of your retirement. Broadly following “age in bonds” (government bonds, specifically) is insurance against such a scenario. In fact, of all the rules of personal finance, “age in bonds” is, in my opinion, the most important. You can pretty much invest in any exotic high-risk asset class (e.g. emerging markets, tech stocks, robotics ETFs, cryptocurrency, etc) but if you own your age in government bonds, you are safe.

When markets go up, it is very easy to rationalize why defensive asset classes are poor quality. It is when markets go up that people easily covert to the cult of equity, but when there is a market crash or when there is a prolonged economic depression that lasts many decades or centures, many will understand and appreciate the wisdom of “age in bonds.” The reality is that when markets are booming, it’s easy to convince yourself why 100% equities or high leverage is a good idea, and the opposite is true when there is a market crash. It goes back to Warren Buffet’s quote about being fearful when others are greedy but also thinking about Ray Dalio’s idea that you must stress test your ideas because you are never be too sure in yourself  because it is easy to be moved by your emotions as well as other psychological biases.

 

 

How Much Passive Income Do You Need?

Most people I speak to, when they want to measure someone’s wealth, measure wealth by referring to how many houses they have. For example, “John owns 14 houses. He is rich.” However, someone may own 14 houses, but each house may only be worth $200k, which gives total assets of $2.8 million. However, what if he also had $2.7 million worth of debt? His net worth would be $100k whereas someone who owns one house worth $1 million that is fully paid off would be 10 times wealthier even though he owns 14 times fewer houses. This example clearly demonstrates how misleading a count of houses is. A more sensible approach is to calculate net worth.

However, net worth can be misleading as well. For example, suppose you inherited a house from your parents that was worth $500k and you live in this house. Suppose suddenly this house went up in value to $1 million. Are you better off? Your net worth has increased by $500k, but because the extra wealth is within the house, you cannot unlock it unless you sell the house. If you sell the house, you’d still need a place to live, so you’d buy another place. The problem is that if you buy another place, that home will have risen in value as well, so the net effect is that you have paid taxes, real estate agent fees, conveyancing fees, etc but there is no difference in your living standards. You are worse off. If you downsize and buy a cheaper place, you’d be able to unlock your extra wealth, but then your living standards drop (e.g. extra commute time).

This point highlights that net worth, although better than a count of houses, has its flaws. An alternative metric, in my opinion, is passive income. Passive income (e.g. from dividend income but also from rent, interest, etc) is income you receive by not working. Passive income should subtract any debt as debt is negative passive income. Debt is the opposite of passive income because you must work to pay off debt. This applies if you hold debt as a liability. If you hold debt as an asset (e.g. you own bonds) then this is passive income. The bonds generate interest for you that you can live off without any work.

Passive income is more useful because it directly measures your standard of living. If your net worth goes up by $500k, that may have zero impact on your standard of living. However, if your passive income goes up by e.g. $1000 per month, that is actual cash in your hands. It directly impacts how much you spend and directly impacts your standard of living.

So how much passive income is enough? It all depends on the person. Everyone is different. It also depends on the city you live in. Some cities are expensive while others are cheap.

However, using Melbourne, Australia for this example, in my opinion, to cover the basic necessities of life, passive income of about A$2000 per month (US$1500 per month) at a minimum is needed, in my opinion.

Currently I work, and I do like my job at the moment, but loving my job is a recent experience. For a long time I have hated my job mainly because I have had bad managers. Something I have learned is that things change all the time at work, so you need to have an exit plan at all times. Too many people get a job, expect they will always love the job and always make good money, so they go into debt to get a mortage, have children, inflate their lifestyle, etc and then suddenly they find they hate their job, but by then they are trapped. I made this realization early on in my career because, when I started working, I went through a restructure in the organisation. I learned quickly how risky it was to have debt and obligations, and I realised the value of structuring your life so that you have the ability to walk away from anything, not just your job but from any person or any organisation. There is great power in being able to disappear at the drop of a hat, and this is achieved with passive income coupled with minimum or no obligation (including financial obligation i.e. debt).

Don’t let yourself get attached to anything you are not willing to walk out on in 30 seconds flat if you feel the heat around the corner.

~ Neil McCauley

Even if there were a restructure at work or a tyrannical manager took over and started legally abusing staff, with passive income of $2000 per month, it is easy to stop work and live an urban hermit lifestyle e.g. renting a one-bedroom unit on the outskirts of the city (e.g. this place in Frankston), living off Aussielent, and surfing the internet all day. The only costs are rent ($1000 per month), Aussielent ($320 per month), wifi ($50 per month), electricity ($100 per month), and water ($100 per month), which comes to a total of $1570 per month. I round that up to $2k per month just to give a little buffer. Nevertheless, this is quite a spartan minimalist lifestyle. Doubling it makes $4k per month passive income, which I feel is enough to really enjoy a comfortable and luxurious lifestyle e.g. travelling, living in the city, eating out, etc. Nevertheless, $2000 to $4000 per month in passive income is a good range to aim for.

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.

Deliberate Ignorance of Net Worth

When I started working, I tracked my net worth religiously. I did it every month. I was living with my parents and saving 80% of my salary. I invested in shares, ETFs, etc, and now I am putting a little into crypto.

However, something that annoyed me was that everyone kept asking about my net worth and they would automatically compare me to this person or that person. Gradually I increased my savings rate to 100% of salary and lived off my investments, but now I don’t bother with checking my net worth. For some reason, everyone keeps trying to pry into my finances. So now I don’t keep track of my net worth. I simply spread all my pay into many different investments and don’t even look at it. I don’t keep track of the performance. I keep myself deliberately ignorant.

People keep asking me when I am going to buy a house, when I will marry, when I will have children, how much I’ve saved, why I am still living with my parents, when will I grow up and be a man, etc, and now I simply tell them that I am a minimalist so don’t want much. I don’t want to be burdened by debt or obligations or social customs. I also don’t keep track of anything so I don’t know my net worth.

The benefit of this is that all the consumerism is gone. People cannot compare anything to me and I too cannot compare myself to others simply because I don’t know how much I am worth. So long as the dividends come in, I just live off it. This I believe is what money is all about: living and having freedom. However, an obsession over net worth distracts people into thinking money is about comparing yourself with others to see who is better, who is “more of a man” or who “has his life together.”

After living like this for a while I found that it is more calming. I no longer compare myself to others and others cannot compare themselves to me. Because I am limited by how much I can spend because I can only spend investment income, I cannot splurge on anything. This keeps me from indulging in consumerism.

My main point is that net worth is important but not as important as passive income. Passive income can keep you alive but net worth doesn’t necessarily do so as your wealth may be locked up in illiquid assets. Furthermore, an obsession on net worth seems to make you obsessive with consumerism and materialism as you’re comparing yourself with others. At the end of the day what matters is freedom, and freedom comes from having no debt, no obligations, and passive income.

Whether You Are a Slave or Not Depends on the Direction of Your Future Cash Flow

 

I couldn’t help think today about how great it is to work. I love working now, but that was not always the case. Only a few months ago I was dreading work. I hated it. I am happy now because I was able to transfer to a different area, and I did this simply by asking someone.

I now work because I want to work. I don’t have to work because I earn dividend income that covers my living expenses. I earn around $25k to $30k per year and I spend around $15 to $20k per year. But I like to work not only because I like my job at the moment but also because I like to grow my dividend income. This means I can improve my standard of living. When I am getting a coffee with my work colleagues, I notice that many of them buy the cheapest option, which is a small coffee with dairy milk whereas I always buy the biggest latte with soy milk or almond milk. Personal finance guru David Bach is anti-coffee (see latte factor) but I am a big believer in small expenses spread over time that make you happy. Getting a coffee is more than a coffee. Some people only care about the caffeine and are willing to stay at their desks and take caffeine pills. For me, getting a coffee allows me to get out of the office, get fresh air and sunlight, get some exercise by walking, and I can chat to my coworkers and even the barista girl who is serving or making my coffee. Then I can slowly sip the warm and smooth coffee when I’m back, which calms me. At any time, I can stop buying coffee. It’s not like a huge debt or a long-term contract. I’m free to walk away. 

For me, small expenses such as a coffee are not a problem. The main problem comes from large expenses, especially those that we put off to the future (i.e. debt). I will explain this in further detail later in this post.

Back to my job…I think I love my work right now because I don’t need to work. I’m happy to put in extra work after hours and over the weekend. I am not a manager or an executive or anything. I am still quite junior. If suddenly things go wrong and I end up with a bad manager, I am confident I can transfer to another area. If things really go bad and I cannot transfer for whatever reason, I can just quit and do something else. I plan to just pack up and go to Chiang Mai and become a freelance web developer. Even if I am not successful, it doesn’t matter because I live off dividends, but it would be nice to work on my own terms.

Recently UberEATS has opened up in my area. I thought about signing up for it and working on the weekend, but I have decided against that because I actually want to use the weekend to focus on learning how to code so that I can be a remote coder or a digital nomad. Today at the library I spent about an hour on Codecademy. I wish I spend my university days studying computer science or software engineering, but my major was in economics, which wasn’t that bad, but if I had to choose again I wouldn’t major in economics. Instead I’d study a tech degree instead. Luckily, many tech workers learn a lot of what they learn online, and they are self-taught, so that gives me hope that I can change careers.

Freedom is the purpose of my life. Freedom gives me happiness. Freedom gives me the option to experiment with and pursue what makes me happy rather than hope that whatever circumstance I am in makes me happy. It was Robert Kiyosaki who introduced me to the importance of cash flow, and I think freedom and slavery can be thought of in terms of cash flow. As much as possible, you want to increase passive income and decrease future obligations. Future obligations are expectations (including the risk) that in the future money will flow away from you. If you take on debt (e.g. a car loan and even a home loan) then in the future some debt collector will take money from you, which forces you to work. Anything that forces you to do something means that you have fewer choices, and so your freedom goes down and your level of slavery increases. Most people think this only applies to monetary debt, which is obvious because it is written down and it’s clear, but even e.g. having children creates future obligations that tie you down. The more you avoid debt, obligation, and commitment, then you increase freedom and reduce slavery. The words “commitment” and “responsibility” or even “duty” are just euphemisms for debt and slavery. If you tell a slave that he must clean a toilet because he is a slave, he will likely try to revolt or may reluctantly clean the toilet and will probably do a bad job at it because his heart is not in it. However, if you reframe and tell the slave that he must clean the toilet because it is his duty or responsibility, he will likely clean the toilet with pride and enthusiasm. So it is that many men proudly work 60+ hours per week at a job they hate just to fund the mortgage on the mansion, the children’s private school fees, the loan for the luxury car, and maybe even a stay-at-home wife as well. If they shirk these obligations, they are told that they are not “responsible” or that they are not fulfilling their “duty” and that they need to “man up” and get back to wage slavery.

In all these situations (car loan, home loan, credit card debt, children, school fees, etc), there is an expectation that money will flow away from you in the future.

Alternatively, if you create passive income from dividend income or even e-book royalties, Adsense revenue, Amazon affiliate revenue, etc, then there is an expectation that money will flow towards you in the future. You then have a choice of what to do with this money. This gives you freedom. It gives you more options rather than reducing your options. It results in less slavery and more freedom.

As much as possible, make money flow towards you in the future rather than away from you. In practice, this means getting rid of all debt, commitment, obligations while simultaneously increasing passive income, mainly from savings, investments, and building businesses.