Australia - New Portfolio Setup and Questions

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Topic Author
dawsone
Posts: 6
Joined: Wed Apr 28, 2021 3:07 am

Australia - New Portfolio Setup and Questions

Post by dawsone »

Country of Residence: Australia

International Lifestyle: We will retire in Australia

Currency: AUD
Emergency funds: $20K in long-term savings account

Debt:
Credit Card: $16K (zero interest debt consolidation for repayment over 28 months)
Tax: $70K (zero interest repayment plan over next 12 months)

Property: We rent our home and will seek to buy when we've built sufficient assets/cash for a deposit.

Age: 47 & 33(spouse) with 2 kids (age 8 & 4)
Income:
Salary: $450K + 9.5% Super

Superannuation: $377K
Super: Aus Ethical Growth Fund: Interest-bearing investments & Cash 15%, Property 10%, Australian and New Zealand Shares 35%, International Shares 30% Alternatives 10%
I am maxing out my $25K super concessional contribution limit and don't make any non-concessional contributions.

Given I am so late to the game of building an investment portfolio, I recently listened to the Little Book of Common Sense Investing and am committed to following this approach. The objective is maximising our financial freedom when I come to retire in 18-20 years time. I have a high risk tolerance and am happy to buy every month and hold for the duration of my working career.

My ideal is a simple approach.

Questions:
1) What is the appropriate asset allocation for someone starting a portfolio in middle age and seeking to maximise retirement income/wealth? Is 100% stocks too aggressive?

2) Further to #1 my financial advisor recommends against including any bonds in my portfolio, as they haven't proven to be as effective at risk mitigation against stock downturns in recent times, and have a very low yield right now. Should I avoid bonds altogether?

3) Which mix of Index funds ought I to include in the portfolio. I am considering a combination of:

Vanguard International Shares Index Fund (secondary consideration hedged or not?)
Vanguard Australian Shares Index Fund
Vanguard Emerging Markets Shares Index Fund

4) What are thoughts on taking an "ethical" approach to fund selection and instead going with:

Vanguard Ethically Conscious International Shares Index Fund
Vanguard Ethically Conscious Australian Shares Fund

Thank you for any thoughts and suggestions, as a newbie to this I appreciate any guidance.
andrew99999
Posts: 812
Joined: Fri Jul 13, 2018 8:14 pm

Re: Australia - New Portfolio Setup and Questions

Post by andrew99999 »

Welcome to the forum.

1. Maximising returns, yes 100% stocks, although I would imagine that if you wanted to, you could have lower risk and still meet reasonable goals with a little more conservative allocation, and then it is up to whatever allocation you can tolerate and not panic-sell when the market has a serious decline.

2. What does your advisor recommend instead of bonds? Bonds have a purpose besides maximising return, much like vegetables have a purpose beyond giving you energy for your muscles, but it doesn't make vegetables useless or worth avoiding.

3. Yes, those 3 will Vanguard index funds give you a fantastic portfolio.
You could potentially include small caps, but it's contentious and the decision can go either way.

4. Do the ethical consierations chosen by Vanguard match your own?
Ben Felix video on sustainable investing is worth watching and expresses my thoughts.
Topic Author
dawsone
Posts: 6
Joined: Wed Apr 28, 2021 3:07 am

Re: Australia - New Portfolio Setup and Questions

Post by dawsone »

andrew99999 wrote: Thu Apr 29, 2021 7:34 am Welcome to the forum.

1. Maximising returns, yes 100% stocks, although I would imagine that if you wanted to, you could have lower risk and still meet reasonable goals with a little more conservative allocation, and then it is up to whatever allocation you can tolerate and not panic-sell when the market has a serious decline.

2. What does your advisor recommend instead of bonds? Bonds have a purpose besides maximising return, much like vegetables have a purpose beyond giving you energy for your muscles, but it doesn't make vegetables useless or worth avoiding.

3. Yes, those 3 will Vanguard index funds give you a fantastic portfolio.
You could potentially include small caps, but it's contentious and the decision can go either way.

4. Do the ethical consierations chosen by Vanguard match your own?
Ben Felix video on sustainable investing is worth watching and expresses my thoughts.
Thank you Andrew 99999 very useful comments and the video was particularly helpful.

In response:

1) Happy to go with 100% stocks and hold through market downturns, at least in this initial period. Will always review AA annually and rebalance as necessary.

2) No alternatives to bonds suggested by my fin adv. what are your thoughts? Please expand on your vegetables analogy.

3) Thank you. Are Small Caps worth further investigation?

4) Your question and the video were great and have helped my wife and I make a clear decision on this.
hi_there
Posts: 794
Joined: Sat Aug 29, 2020 7:00 pm

Re: Australia - New Portfolio Setup and Questions

Post by hi_there »

Others have provided answers to the questions. But for the information of this primarily non-Australian audience (as far as I can tell), what does retirement look like in Australia? Is there a pension system, healthcare, and other social insurance?

Also, you would have to consider whether the 33-year-old spouse will retire much later than the 47-year-old, and the relative earnings potential of the two spouses, as this affects your investment time horizon too.
andrew99999
Posts: 812
Joined: Fri Jul 13, 2018 8:14 pm

Re: Australia - New Portfolio Setup and Questions

Post by andrew99999 »

dawsone wrote: Fri Apr 30, 2021 5:46 pm Thank you Andrew 99999 very useful comments and the video was particularly helpful.

In response:

1) Happy to go with 100% stocks and hold through market downturns, at least in this initial period. Will always review AA annually and rebalance as necessary.

2) No alternatives to bonds suggested by my fin adv. what are your thoughts? Please expand on your vegetables analogy.

3) Thank you. Are Small Caps worth further investigation?

4) Your question and the video were great and have helped my wife and I make a clear decision on this.


Bonds serve a few different purposes. For instance:

1. Some stable money available when the shit hits the fan, and you need to avoid selling equities when they're half price and depleting your equities at double the speed and taking much longer to recover.
2. Because it's hard to stomach your life savings falling to the value it was many years earlier and not knowing if it will take a decade or more for the market to recover (yes, this has happened).
3. To protect the money that you've earned.
4. Diversification from equities. Equities do great when the economy is booming, but during other parts of the economic cycle, their risk shows up, and bonds can be a great way to diversify into something uncorrelated. High-quality bonds usually (not always, but usually) tends to do well when equities are doing badly.

If you don't need them, 100% equities is fine. Just be aware that the purpose of bonds is not to maximise your gains. They have other uses.

I'm also particularly concerned that your advisor advised against bonds based on low return and the idea that they did not diversify. There are certainly good advisors, but they are eclipsed by those that aren't.

----

Hmm .. I use small caps primarily to diversify out of megacorps that make up so much of the index, as expected since it is weighted by capitalisation. There are many ways to diversify out of megacorps (small caps, value stocks, REITs, infrastructure, long term bonds, EM bonds, etc.), but including all those will make for a complicated portfolio. I like EM, and then the rest are right on the line of whether to include or exclude one of them. In my opinion, you aren't going to suddenly go from a terrible portfolio to a fantastic portfolio by including small caps, and leaving them out is a reasonable option.
Topic Author
dawsone
Posts: 6
Joined: Wed Apr 28, 2021 3:07 am

Re: Australia - New Portfolio Setup and Questions

Post by dawsone »

hi_there wrote: Fri Apr 30, 2021 5:51 pm Others have provided answers to the questions. But for the information of this primarily non-Australian audience (as far as I can tell), what does retirement look like in Australia? Is there a pension system, healthcare, and other social insurance?

Also, you would have to consider whether the 33-year-old spouse will retire much later than the 47-year-old, and the relative earnings potential of the two spouses, as this affects your investment time horizon too.
Thanks for your questions and comments hi_there.

In Australia there is a compulsory pre-tax employer contribution of 9.5% (of salary) into the employee’s superannuation (pension) fund. The employee has full control over which superannuation fund this is. So all full-time employees are by default making regular superannuation contributions. Employees scan salary sacrifice to make additional pre-tax contributions, up to a cap of $25k per year.

Australia does have a government funded pension scheme too, which is subject to an income test and the assets test. Both of which we will not pass/be eligible for given our personal superannuation funds.

We also have a national health system called Medicare, which is not unlike the UKs NHS, in that it is a universal health system funded by the government.

On your second point, my wife is currently a full-time mother and doesn’t have any income. Her earning potential is considerably less than mine even if she returns to work in a couple of years time, so we are planning our finances based on an earning potential of zero. Any earnings she does make in future will improve the plan, rather than being integral to it. She will be eligible to access her superannuation at age 60, which she will reach 9 years after I intend to retire, when I reach age 65.
Topic Author
dawsone
Posts: 6
Joined: Wed Apr 28, 2021 3:07 am

Re: Australia - New Portfolio Setup and Questions

Post by dawsone »

andrew99999 wrote: Sat May 01, 2021 12:36 am
Bonds serve a few different purposes. For instance:

1. Some stable money available when the shit hits the fan, and you need to avoid selling equities when they're half price and depleting your equities at double the speed and taking much longer to recover.
2. Because it's hard to stomach your life savings falling to the value it was many years earlier and not knowing if it will take a decade or more for the market to recover (yes, this has happened).
3. To protect the money that you've earned.
4. Diversification from equities. Equities do great when the economy is booming, but during other parts of the economic cycle, their risk shows up, and bonds can be a great way to diversify into something uncorrelated. High-quality bonds usually (not always, but usually) tends to do well when equities are doing badly.

If you don't need them, 100% equities is fine. Just be aware that the purpose of bonds is not to maximise your gains. They have other uses.

I'm also particularly concerned that your advisor advised against bonds based on low return and the idea that they did not diversify. There are certainly good advisors, but they are eclipsed by those that aren't.

----

Hmm .. I use small caps primarily to diversify out of megacorps that make up so much of the index, as expected since it is weighted by capitalisation. There are many ways to diversify out of megacorps (small caps, value stocks, REITs, infrastructure, long term bonds, EM bonds, etc.), but including all those will make for a complicated portfolio. I like EM, and then the rest are right on the line of whether to include or exclude one of them. In my opinion, you aren't going to suddenly go from a terrible portfolio to a fantastic portfolio by including small caps, and leaving them out is a reasonable option.
Thanks again andrew99999

I took a look at what Bond Index Funds Vanguard have here in Australia, and there doesn't seem to be an EM option available as part my diversification strategy.

Based on my research and your commetns above the AA I am considering is:

Vanguard International Shares Index Fund 40%
Vanguard Australian Shares Index Fund 20%
Vanguard Emerging Markets Shares Index Fund 20%
Vanguard Australian Corporate Fixed Interest Index Fund 20%
(based on there being no EM bond index fund available with Vanguard in Aus, and this is the next best thing in terms of return and risk profile, on which I'm happy to be corrected or guided otherwise.)

Very grateful for your guidance so far and look forward to any feedback on the above.
andrew99999
Posts: 812
Joined: Fri Jul 13, 2018 8:14 pm

Re: Australia - New Portfolio Setup and Questions

Post by andrew99999 »

dawsone wrote: Sun May 02, 2021 6:23 pm Based on my research and your commetns above the AA I am considering is:

Vanguard International Shares Index Fund 40%
Vanguard Australian Shares Index Fund 20%
Vanguard Emerging Markets Shares Index Fund 20%
Vanguard Australian Corporate Fixed Interest Index Fund 20%
(based on there being no EM bond index fund available with Vanguard in Aus, and this is the next best thing in terms of return and risk profile, on which I'm happy to be corrected or guided otherwise.)
There is an EM bond fund with Blackrock (IHEB). Remember that bonds (and even more so for high yield bonds such as corporate bonds and EM bonds), are tax-inefficient in that you have to pay tax on most of the return each year instead of capital gain heavy assets like shares where you can earn money on delayed tax payment for potentially decades.

It's also very important to understand that EM bonds and high yield corporate bonds are risky assets. Many will see the word "bonds" and assume it means safe, but these 2 types of bonds belong in your risky asset allocation and miss out on the 4 points I mentioned previously about bonds. There is still some level of diversification (as in point 4), but not the same as high-quality bonds like government bonds.

What is the purpose you are looking for in regards to bonds?
Topic Author
dawsone
Posts: 6
Joined: Wed Apr 28, 2021 3:07 am

Re: Australia - New Portfolio Setup and Questions

Post by dawsone »

andrew99999 wrote: Mon May 03, 2021 12:02 am
There is an EM bond fund with Blackrock (IHEB). Remember that bonds (and even more so for high yield bonds such as corporate bonds and EM bonds), are tax-inefficient in that you have to pay tax on most of the return each year instead of capital gain heavy assets like shares where you can earn money on delayed tax payment for potentially decades.

It's also very important to understand that EM bonds and high yield corporate bonds are risky assets. Many will see the word "bonds" and assume it means safe, but these 2 types of bonds belong in your risky asset allocation and miss out on the 4 points I mentioned previously about bonds. There is still some level of diversification (as in point 4), but not the same as high-quality bonds like government bonds.

What is the purpose you are looking for in regards to bonds?
The two points that caused me to consider including bonds were 1) stable money available when the shit hits the fan... and 4) Diversification (specifically out of Megacorps as you suggested).

Perhaps based on your comments I ought to consider lower risk & yield government bonds for diversification and stable money availability?
Or revert to my original higher risk high return AA of 100% equities and make sure I build sufficient cash reserves to weather any storms...?

Sorry for the back and forth, I am very grateful for yoru guidance on comments as I embark on this journey.
andrew99999
Posts: 812
Joined: Fri Jul 13, 2018 8:14 pm

Re: Australia - New Portfolio Setup and Questions

Post by andrew99999 »

EM bonds and corporate bonds won't help much when the economy takes a hit. Those points were for high-quality bonds.

I would suggest deciding if you want some increased portfolio stability and having money available when the economy takes a hit. If so, add some high-quality bonds (or use a high-interest savings account). This will reduce your return, but there is no escaping that — risk and expected return are joined at the hip. Note that at the end of 100% stocks, the reduction in expected return is very low vs the risk reduction. You can see the concept in the below image from Rick Ferri's book on asset allocation.

Image
Topic Author
dawsone
Posts: 6
Joined: Wed Apr 28, 2021 3:07 am

Re: Australia - New Portfolio Setup and Questions

Post by dawsone »

andrew99999 wrote: Mon May 03, 2021 4:18 am EM bonds and corporate bonds won't help much when the economy takes a hit. Those points were for high-quality bonds.

I would suggest deciding if you want some increased portfolio stability and having money available when the economy takes a hit. If so, add some high-quality bonds (or use a high-interest savings account). This will reduce your return, but there is no escaping that — risk and expected return are joined at the hip. Note that at the end of 100% stocks, the reduction in expected return is very low vs the risk reduction. You can see the concept in the below image from Rick Ferri's book on asset allocation.

Image
Thank you so much for helping me crystalise my thoughts and needs. This is hugely helpful input.
I'll reflect and move forward. Based on your risk vs return comment re 100% stocks, I suspect I'll land on some high quality bonds as a small minority of the portfolio (10-20%).
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