Our series on why you must get out of debt looked at how credit cards can double the price you pay, at the cost of foregone investments, and why mortgages are the only good debt.

But there’s another reason to get out of debt.

It’s hard to price, but it may be the most valuable benefit of all.

It’s the peace of mind and the freedom to make money that comes with being debt-free.

When you’ve no debts, you literally don’t owe anyone anything. Your money is yours to use as you will.

Sure, you may feel you owe:

• Your parents for raising you
• Your friends for the good times
• A beer to anyone who helped you in the bad times
• Whoever gave you that spare bed in my third debt article

But financially-speaking, you’re free.

Many people who get out of debt unfortunately use that freedom to go straight back into the mire. They fill the void left by paying off their debts with… more debt.

A better plan is to keep up the momentum to grow your net worth. Redirect your former debt repayments towards saving and investing. Use your new financial flexibility to increase your earnings.

You can start investing with a tiny budget – indeed it’s free with Freetrade. ((Open an account via that link and we can both get a free share worth between £3 and £200. You’re growing your net worth already!))

The important thing is to get your snowball rolling!

Make money for yourself, not some bank

I’ve heard many times from people how liberating getting out of debt is.

They discover what I relish every day – that my monthly income is going wherever I want it to go, not on paying for stuff bought and forgotten about years ago.

Debt-free, you can save up an emergency fund, invest to create a future income – or just treat yourself to a meal out or new pair of shoes, guilt-free.

And here’s the real bonus – when you’re financially secure, you’re also more likely to look for ways to make money.

Everyone knows the rich get richer. Having compound interest working for you instead of against you is a big reason why.

But I believe there’s also a mental pay-off for being debt-free.

Operating from a position of strength, you are more able to think of money as an opportunity and a tool, rather than as a burden. Your whole outlook on money and the language you use can change. And that’s the first step to getting richer.

My co-blogger The Accumulator had to get out from under his debts before he could begin amassing his passive hoard and planning for financial independence.

As someone who has never borrowed money and so started investing with a clean state, I find his journey inspiring.

But I’d choose my debt-free journey over it, any day.

What about my pal Bob / Aunt Bertha / Donald Trump?

Sure, we all know a few people who (seem to) handle their debts and still grow their income faster than their repayments.

I’m not saying debt is always a fatal disease. Rather, that it’s a hugely debilitating one, which can easily catch up and snuff out its victims.

How much wealthier would those income-rich, asset-poor debt jugglers be if instead of shuffling credit card payments, they put their brainpower into growing their investments or creating a passive income stream?

Mortgages: The exception to the rule

If you’ve got any non-mortgage debt – even if you think it’s balanced by assets – pay it off as soon as you can. In every way it’s worth it.

Using debt to buy a property is the only exception. A mortgage is cheap debt, and it enables you to live in your own home today rather than saving half your life to buy one, chasing rising house prices along the way.

Nowadays even I have a big interest-only mortgage, and I truly hate debt.

But do you want to know a secret?

I love my home and overall I’m happier for finally owning my own place.

But I believe I was a better investor when I didn’t have a mortgage hanging over me.

The bottom line on debt

For most Monevator readers, I’m preaching to the choir.

But too many average people have too much debt – and it’s in tough times like recessions that they discover why they shouldn’t.

It can be hard to get out of debt. You’ll have to go without.

But all that really matters in life is health, friends, family, love, and useful work or another purpose you enjoy.

Well, and beauty and truth, as the poet said.

(And personally I’d add Mexican food.)

Last I looked, getting into debt to buy an iPad when you can’t afford it just to have one before your friends wasn’t on a single philosopher’s list.

This is one of the most revealing stock market charts I’ve ever seen. It shows just how rough the ride is when you invest in equities – in this case the FTSE All-Share index:

Source: J.P. Morgan Guide to the Markets UK, 31 March 2020, p.92 (updated quarterly). ((Nominal returns, dividends not included.))

Most investing books show only calendar-year returns when they explain how risky the stock market is. You can see these calendar year returns for the All-Share represented by the grey bars in the graph.

They go up and down like a lift operated by Mad Max. But even these violent mood swings are mild in comparison to the worst drawdowns ((Drawdowns are the decline in the price of an investment between its high and its low over a given period.)) contained within each year, picked out in red dots.

Those plunges really will make your stomach drop.

Market mania

What do 34 years of stock market swings and roundabouts tell us?

Firstly the -36% fall we saw through March 2020 is historically horrendous.

It’s beaten on the chart only by the -37% Black Monday Crash of 1987 and the -43% delivered during the Global Financial Crisis in 2008.

The main lesson though is that double-digit losses are a regular event, bedevilling investors in UK equities in more than 75% of the years covered.

On top of that:

• A market correction (-10% to -19%) hit home more years than not (18 out of 34 years).

• We entered bear market territory (-20% or worse) in nearly 25% of all years (eight out of 34 years).

• Peak-to-trough losses were -30% or greater in five out of 34 years (that’s 15% of all years).

JP Morgan calculates the average intra-year drop is -15%. That shows 100% equities is no place for the nervous and attentive, even though the market ended up higher in a given year some 70% of the time.

Happily the years that saw double-digit declines still ended up in positive territory 44% of the time (15 out of 34 years), too.

Down but not out

Even truly terrible drawdowns can reverse quickly. 1987’s -37% decline transformed into a 4% gain by New Year’s Eve.

I can’t see that happening this year, and it didn’t happen during any of the other 30%+ down years either, but who knows?

Many other big losses rebounded into big gains:

• 2009’s 23% down snapped back to 25% up.
• 1999 dived 11% but rose 21%.
• 1989 dropped 14% but climbed up 30%.

For new investors, this chart provides a more realistic picture of what you’re up against than you’ll get by just looking at the end-of-year tally. Equities are a much tougher place to be than I realised when I began investing, when seen through the lens of intra-year declines.

For example, the most brutal calendar year for UK equities was an off-the-charts -58% delivered in 1974. ((Barclays Equity Gilt Study, real return including dividends.))

Yet even that pales against the sickening -73% inflicted by the UK bear market of May 1972 to December 1974. ((Sarasin Compendium Of Investment 2020, p.167.))

Forewarned is forearmed

Why am I heaping this misery on you when we’ve possibly only just binged on the first few episodes of an all-time equity horror show?

Partly because the graphic shows some good news. Things can – and often do – turn around more quickly than we think.

But also to be honest about the bad news. The stock market is a wilder place than many give it credit for.

Chalk it up as yet another reason to invest passively, to be diversified, and to only check your portfolio infrequently, lest you’re frightened out of it…

Take it steady,

The Accumulator

What caught my eye this week.

Remember a thousand years ago – or more precisely, in March – when we watched with horror news stories of Italian hospitals overwhelmed with patients and footage of sullen families barricaded inside their homes?

I think most of us failed to connect what was happening on TV with what could happen here.

Oh, I understand not you – you saw it all coming.

Me too, of course, as I’ve banged on about for months.

Well… maybe.

The truth is it’s very hard to truly envisage a reality revamp until it slaps you in the face.

In mid-February a good friend of mine was banging her head against the wall because all the factories she dealt with every day in China had shut-up shop. All of them!

In theory I knew this from the financial news – I’m a stock market junkie, after all.

What’s more I’d had a morbid fascination since January with what we then called the ‘novel coronavirus’.

But it wasn’t until I saw my friend despairing for her business – right there in front of me – that I truly weighed up what would happen if the virus got here. And then I sold some shares.

I think we’re in a similar place with the economy.

Look out below

Most people now understand that a lockdown craters the economy. The statistics are coming in every day – I’ve included a few in the links below – so it’s impossible to refute.

The debate now is how quickly we can bounce back, and to some extent whether it will prove to have been worth it.

But I don’t think any of us are really processing what this graph might look like in real-life:

The graph comes courtesy of the Bank of England, which this week told us it expects GDP to decline 14% in 2020 as a whole before rebounding 15% in 2021. It will be the worse slump for 300 years.

Does it yet feel like the worst slump in 300 years to you? Are we all so sanguine because we’re confident we’ll see the same ‘V’ that the Bank of England is sticking up in front of us?

Or are we not actually thinking about it?

Will we even get such a strong bounceback, after such disruptive chaos?

Economic forecasting is a thankless task and I don’t envy them their job, but these guys haven’t exactly covered themselves with glory with their predictions over the years. Anyone who has followed the inflation target saga can tell you that.

I do hope we’ll see a ‘V’, and provided Covid-19 quietens down it’s what you’d logically expect. Whatever the pros and cons of our economy, the recession we’re in wasn’t precipitated because the economy was structurally overwhelmed. It’s more like a storm that superficially smashes the place up (the pandemic), as opposed to dry rot that ruins the foundations from the inside out (sub-prime mortgages or dotcom valuations or over-powerful unions or too much crappy investment or whatnot).

If the big bazookas being fired this way and that by the Government and the Bank of England have done the trick, we’ll have stunned the economy senseless for three months, but we could emerge something like how we went into it.

If…

The new most hated rally of all time

Time will tell. As for the stock market, I’m still not as offended by the rally as most people.

Central Bank action has lopped off the truly disastrous tail risks that the market was facing in March.

After that, the shares that have rallied the most are by far the superior companies. As I’ve mentioned before, in many cases they’re companies directly benefiting from global lockdown Even where they’re not, their valuations are typically based on earnings due far into the future.

In contrast, the hardest hit firms are mostly still in the dumpster.

Also consider when exactly we’re likely to see meaningfully higher interest rates.

I have I hard time imagining UK Bank Rate reaching even 2% by 2030. Anything is possible, but for reference a 30-year gilt is currently yielding 0.53% so don’t hold your breath.

I bought my flat after a decade of prevarication and got my stupidly big mortgage because I finally became convinced rates weren’t going anywhere in a hurry. That was more than two years ago. Now future rate rises will take the extra-scenic route, and stop off in every quaint village along the way.

Companies that survive the imminent recession are almost certainly going to do much better than cash in the bank over the next 10 years. If some of the world’s 1% have the spare money to buy them now while they’re still – just about – on sale, is it any surprise?

Of course markets can do anything, so it equally wouldn’t surprise me if we saw the indices halve again by Christmas. I’m just saying I don’t think the rally is unjustified.

Anyway have a great long weekend, and I hope neither the virus nor the counter-measures have laid you too low!

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