A couple of years ago I buffed up my crystal ball with Mr Sheen but the picture was still a dark one. Specifically, the risk to near-term retirees running into a poor sequence of returns looked high to me.

As things turned out, soaring inflation together with tumbling equity and especially bond markets did indeed make 2022 a year to forget for diversified investors.

One crappy year is easy to ride out when you’re young, accumulating savings, and many years away from pulling the plug. Lower prices are a bonus, enabling you to buy assets more cheaply.

However a bear market is a scarier and potentially more damaging prospect around retirement age.

Sequence of returns risk turns on the order in which investment returns occur. And we need to pay particular attention in the early years of retirement.

Negative returns at the start of retirement can lop chunks off the longevity of a retirement portfolio, due to your need to make withdrawals for income from your shrinking pot.

That’s true even if you eventually see decent average annual returns over the length of your retirement.

The bright side

Hopefully the pointers in my piece on how to soften the blow were helpful if you were retiring – or just thinking about it – in 2022. 

What’s more, the worst of the portfolio drawdown was short-lived. Equity gains in 2023 and 2024 – beginning shortly after the Truss fuss – plastered over much of the damage. At least in nominal terms.

On the other hand, while bonds long ago stopped plunging, they’ve barely bounced. Bonds are like a coin that’s fallen out of your pocket to skitter beneath the sofa. Down, out of sight, and maybe out of mind.

As for inflation, thankfully it’s returned to near-target levels. But that doesn’t undo the prior period of very fast rising prices.

Downgraded retirement dreams

Once prices go up they usually stay up. That’s what makes runaway inflation so terrifying to those on fixed incomes.

The Pension and Lifetime Savings Association has hiked by 34% its estimate of the annual income required for a ‘comfortable retirement’ for a single person, compared to 2022. That’s more than enough to eat into the income buffer of almost any plan.

We can debate the PLSA’s assumptions (and Monevator readers did at the time). But everyone agrees the cost-of-living has soared.

For many retirees, this will mean a much tighter spending budget than they expected to play with. Or even a return to work for some.

Things could only get better

It’s important to stress that those who retired in 2021 or 2022 aren’t doomed to penury, just because of a single annus horribilis.

Sustainable withdrawal rate assumptions underpin many plans – often simplified to the 4% rule. And these are backtested across far worse bear markets and inflationary episodes than our recent wobble.

Think wars, depressions, and even gnarlier inflation.

True, the 2022 vintage of retirees will see lower returns in the future from pulling their 4%-or-whatever out of a smaller pot of savings in the first year. That’s just maths.

They’ll probably more feel the pain of higher prices too, compared to someone whose portfolio was fattened for years before we ran into the inflationary buzzsaw.

But assuming they had enough money at the start to prudently retire in a sustainable way, the past couple of years shouldn’t derail them.

Yet at the same time, anyone who delayed retirement until after bonds had finished their swan dive and inflation its Olympic high jump might be feeling quite smug today.

Bonds are back

Much of what dinged the prospects for a 2022 retiree now gives today’s sufficiently well-funded retiree more reason to look forward to life on their 4% – or thereabouts – withdrawal rate.

Note: I’m not forecasting a bull market here. (Nor was I predicting a certain equity crash in 2022.)

Forecasting future equity returns, especially over the short-term, is either very hard or impossible, depending on who you believe. Equity valuation levels can give us a clue to longer-term returns. And very high valuations do tend to point to lower returns eventually. But even this method isn’t foolproof, and it’s definitely no short-term timing signal.

However things are different with bonds (and perhaps also with so-called bond proxies).

Bond maths rules the roost. Higher bond yields will deliver higher future returns, versus lower yields.

Conversely, very low yields on bonds was exactly what made the outlook in early 2022 so troublesome. As central banks hiked interest rates aggressively against a backdrop of rocketing inflation, bond prices were nailed-on to fall.

In the end yields across the market went much higher than almost anyone had predicted, putting bond prices in the dumpster.

It was the worst bond rout of all-time in the US – and the UK was not far behind.

But those same falls also transformed the prospects for bonds. The negative bond yields of a few years ago have been vanquished. Even after a recent rally, ten-year gilts are still yielding 3.9% nominal. Buy and hold such a bond to maturity and that’s the return you’ll get.

It’s a similar story with inflation-linked bonds and – to widen the lens – annuities.

A better time to retire on an annuity

The following table shows changes in annuity rates since December 2021:

Source: Sharing Pensions

To be sure, annuity payouts need to be higher – inflation pumped up retirement costs by 30% or more remember. Yet even that vertiginous ascent has been outpaced by the rise in what £100,000 now gets you.

Property rental yields have risen too – albeit offset by higher borrowing costs – for those who still fancy the challenged buy-to-let route to a retirement income.

Naturally speaking, incomes are higher

We can also see the better sitrep for today’s imminent retirees by considering the level of natural yield your money now buys you.

Aiming to live on the income thrown off your portfolio is controversial. I won’t re-litigate the pros and cons in this post. I’m not suggesting this is how you should invest your retirement savings or that lifelong passive investors should buy active funds.

See my Mavens post from January if you’re curious.

Instead let’s simply consider the sort of hands-off-ish portfolio I personally might put together, assuming I wanted to live on a natural yield today. Just as a pointer to the value on offer:

Asset	Allocation (%)	Yield (%)
JP Morgan Claverhouse	10	5.0
Murray Income	10	4.4
City of London Trust	10	4.7
Bankers Investment Trust	10	2.4
Henderson Far East Income	5	10.8
Renewable Trusts basket	5	7.5
Infrastructure Trusts basket	5	6.5
UK Property REIT (IUKP)	5	3.7
Intermediate (10yr) gilts	20	3.9
Index-linked gilt ladder	20	0.5*
	Portfolio yield	4.0%

Source: AIC, ETF factsheets, author’s calculations and guesstimates. *See comment #9 below for more on the index-linked yield, which is real where the others are nominal.

Despite my allocating a fifth of the portfolio to index-linked gilts for safety reasons, we’re still hitting a 4% initial natural yield, which I have every reason to believe would grow over time – and with a decent shot of keeping up with inflation over the long-term.

Compare that to when I sounded the sequence of returns alarm in early 2022.

The 10-year was then yielding about 1.6% and the yield on linkers was negative. Without looking back and doing a deep comparison, I know equity income trusts were on average around par so we can assume slightly lower yields, while infrastructure and renewable trusts were about to nosedive from high premiums to deep discounts. I’d estimate that added about 200 basis points to their running yields.

If I plug my 2022 yield guesswork into the same assets I get an estimated 2022 yield of just 2.9%.

This isn’t even to talk about the pounding of capital values that was about to hit such a portfolio over the rest of 2022 and beyond – from which it wouldn’t have yet recovered.

Indulging retirement daydreams

Of course you might reasonably argue that if you were being active about things, then perhaps you’d have owned a different portfolio in 2022.

A global tracker didn’t yield much in 2022, but it’s well up in capital terms over the past two years.

However I stress again I’m not citing this portfolio to sneak in a pitch for natural yield. I’m just showing how the re-pricing of assets – and the taming of inflation – might make today’s retirees more confident.

Of course inflation may not be tamed.

Inflation erodes the purchasing power of your money, making it one of the biggest threats to retirement income. As we saw above higher inflation also means higher living costs. If inflation takes off again then my example 4% nominal yield will obviously wilt in real terms.

But as best I can tell the omens on inflation look good.

Higher yields make this a better time to retire

Of course an equity market crash could happen at any time, too.

The US in particular still looks historically expensive, despite the recent wobble. While that doesn’t mean it’s sure to decline, it does mean we should curb our expectations for equity returns on a ten-year view. Especially given the big proportion the US makes up of global tracker funds. (Around two-thirds).

This isn’t like after the global financial crisis, when you could feel fairly confident you were buying up bargains.

On the other hand, much of the rest of the world’s equities look fairly valued. And my own income preference – to lean into equity income trusts – would see my hypothetical portfolio very tilted towards UK equities, which seems a pretty good place to be. The UK market has only just started coming back into favour.

But most importantly, far higher bond yields – and the repricing away of crash-risk in these assets – means you can diversify a portfolio without feeling like you’re sitting on a box of nitroglycerine.

I’d far rather start from here than there!

The great financial educator William Bernstein said: “You have to understand what market history looks like. What market history tells you is that the very, very best investments are made when things look the worst.”

It’s for similar reasons that I write so often about the past. I want to try to understand what fleeting or lasting horrors my investment choices might inflict even before any rewards come due.

This means examining as fully as possible the asset classes that comprise today’s investing mainstays.

First-world problems

Most Monevator readers’ portfolios are dominated by World equities – that is, developed world stocks.

But there’s a problem if you want to know how the World index has performed over the long-term. 

Which is that the two benchmarks that stretch back farthest are pay-walled.

Fair enough, I suppose. Professors’ Dimson, Marsh and Staunton’s DMS database and Global Financial Data’s indices are both based on exhuming stock returns from fusty old journals and ancient newspaper archives. Someone’s got to keep the wonks fed and watered.

But that doesn’t help the investor in the street. People like us who are keen to avoid becoming investors out on the street, by educating ourselves in the ways of the investing world.

True, you could simply use the MSCI World’s easily-accessed tale of the tape. Its data runs from 1970.

But in my view that paints too benign a picture.

No Great Depression, no World Wars, no decade of deflation, no deglobalisation.

While 50-odd years sounds like a long time, we can only really see how equities responded to a wide set of conditions by retrieving the greater part of the 20th Century.

Introducing a new world index

We need more open-source data. And I’ve found it!

Enough to create a World index reaching back to 1919:

• I’ve taken historical country-level stock market returns from the Macrohistory database.
• I then weighted each country using stock market capitalisation data from the paper, The Big Bang: Stock Market Capitalization in the Long Run.
• Then I currency-converted all the results to GBP1 using exchange rate data from the Macrohistory team. 

This process enabled me to assemble a World index in GBP that begins in the aftermath of World War One. At the other end of the timeline, the new index segues into the MSCI World GBP from 1970.

The resulting World equity index is not perfect (and I’ll explain why further down) but I believe it’s good enough.

So I’ll use this index to represent the World equities portfolio in future Monevator long-term performance articles.

In the meantime, the rest of this article will chart how world equities have fared from 1919 to 2023.

Then I’ll briefly pop the bonnet on the index as a treat for the hardcore at the fag end – I mean the grand finale – of this piece.

Investing returns sidebar – All returns quoted in this piece are real annualised total returns. That is, they’re the average annual return (accounting for gains and losses) realised in a given time period. These returns include the impact of reinvested dividends, but strip out the vanity growth delivered by inflation that does nothing to boost your actual spending power. Local currency returns have been converted to GBP.

World index: long-term equities growth

Here’s the World equities growth chart using our new index versus two rival long-term benchmarks: US and UK equities:

Data from JST Macrohistory2, The Big Bang3, MSCI, Aswath Damodaran, and FTSE Russell.
August 2024

The graph reminds us again that the rest of the advanced world has struggled to keep pace with US equities since the mid-1990s, aside from a brief panic room huddle during the Global Financial Crisis.

We can also see that home bias cost UK investors dearly throughout – even though the UK has remained one of the world’s top-performing markets over time.

World index annualised returns in GBP (% per annum)

Let’s now look at the long-term average real return numbers with dividends:

	2023	10 years	20 years	50 years	105 years
World equities	8.9	8.4	6.7	5.5	6.7
US equities	16.5	11.6	8.3	7.5	7.7
UK equities	0.6	2.3	4	6.2	5.6

The US wipes the floor with the rest of the world across every timeframe. Particularly in the last ten years as the ascendency of Big Tech – and its concentration in US stock markets – has left competing sectors looking like yesterday’s news.

It would be interesting to see whether the US still dominates in an alternative world with the Big Tech winners stripped out. We’ll save that for another time.

World index: annual returns

Annual World index results resemble any other crazy equity returns chart. They look like an abstract cityscape of soaring skyscrapers and deep shafts boring into negative space.

Happily however the towering returns outnumber the dark days lost in bunkers.

Thus somehow our long-term financial wellbeing emerges from this profile of sky-dwellers and underlanders.

Annual returns: World vs US vs UK stock market indices

A question: does diversifying across the world take the edge off those trips to the bargain basement?

This chart indicates that the World index might provide some downside protection relative to single country markets.

The cyan bars seem to punch shallower holes than the USA’s red. Though also notice how dynamically America tends to bounce back.

Drawdowns: World vs US vs UK stock market indices

This is the trauma room chart: a raw record of loss and terrible stock market slashes. All the same, you can see how the Great Depression is mitigated by the World index versus the US during the 1930s. (The impact of the Great Depression was not so severe in the UK, for one thing.)

World War 2 and subsequent recessions were also typically blunted by a World stock assemblage.

A notable exception is the early 1990s slump when the Japanese stock market bubble burst. The Tokyo stock exchange comprised over 40% of the index in 1989 but it made up only 11% ten years later.

Holding the World portfolio also exacerbated the Dotcom Bust of the early 2000s, as Japan continued to sell off and the UK piled on the pain too.

The risk-adjusted view

All told, our eyes do not deceive us. The numbers show that the World index has inflicted less volatility on investors over the long-run (1919-2023):

Index–	Annualised return–	Volatility–	Sharpe ratio
World	6.7%	17.4%	0.38
US	7.7%	19.7%	0.39
UK	5.6%	20.5%	0.27

The higher your Sharpe ratio, the better your risk-adjusted returns. That is, the more return you get per unit of risk as measured by volatility.

From this we can conclude that the World has proved about as worthwhile a buy as the US when returns are costed against the volatility you endured to attain them. (This is the essence of the Sharpe Ratio measure.)

Viewing the benchmarks on the single dimension of returns would imply that world equity diversification has proved sub-optimal, compared to if you’d gone all-in on the US.

But taking that broader view reveals how the rest of the world offers good reason not to pin all our hopes on perpetual American exceptionalism.

World index market share

The MSCI World is utterly dominated by the US stock market these days. It currently weighs in at a 71.7% share of the index:

Source: MSCI. August 2024

Our investing fate is inevitably reliant on the world’s most important capital market, though that’s nothing new.

This next chart compares the market capitalisation of each of the major developed world stock markets:

Source: The Big Bang. August 2024.

We can see that the US has almost always been the biggest player – offset to a greater or lesser degree by the UK, Japan, France, Germany, and the plethora of smaller fish known as ‘Other’.

Since 1919, the US share of the world market has ranged from 31% (1988) to 73% (1951).

For what it’s worth, the US is close to its historical ceiling right now.

Inside the World index

I want to emphasise that the World index presented here is not the global index.

I’m relying on MSCI World figures from 1970 onwards. That index excludes the emerging markets. Its Asian representatives are limited to Japan, Singapore, and Hong Kong.

Pre-1970, I use Macrohistory’s country list. That is limited to the Anglosphere, Japan, and Europe.

Macrohistory’s research omits Austria, New Zealand, Ireland, and Eastern Europe.

Indeed, it’s the absence of Austria and Russia that enforced our 1919 cut-off. Those two imperial stock markets weighed about 5% each before World War One intervened (by the light of the DMS database).

South Africa is the other notable no-show. Its stock market accounted for a couple of percentage points of the whole during most of the period.

Every benchmark makes some exclusions for reasons of practicability. Ours are imposed by the limits of publicly available data.

Even so, we’re happy that our numbers are a credible representation of the historical World index. The loss of fidelity versus commercial alternatives doesn’t change the lessons we can learn.

Finally, I’d just like to thank the academics responsible for the Macrohistory database and The Big Bang research. They have created an immense resource and been incredibly generous in freely sharing it with the world.

Thank you Òscar Jordà, Katharina Knoll, Dmitry Kuvshinov, Moritz Schularick, Alan M. Taylor, and Kaspar Zimmermann.

Take it steady,

The Accumulator

1. British Pounds Sterling. [↩]
2. Òscar Jordà, Katharina Knoll, Dmitry Kuvshinov, Moritz Schularick, and Alan M. Taylor. 2019. “The Rate of Return on Everything, 1870–2015.” Quarterly Journal of Economics, 134(3), 1225-1298. [↩]
3. Dmitry Kuvshinov and Kaspar Zimmermann. 2021. The
   Big Bang: Stock Market Capitalization in the Long Run. Journal of Financial Economics,
   Forthcoming. [↩]

What caught my eye this week.

I am just back from two days away for a wedding with a slightly sore head, a very favourably updated impression of Liverpool, and our regular weekend links only now finalised and tidied up.

Oh, and also to the discovery this morning that I hadn’t done as badly as I’d gathered from furtive half-glimpses at my live portfolio-tracking spreadsheet in the quiet moments before the cake was cut.

Rather, I’d forgotten one of my recently re-upped stocks was due a 10-to-one stock split at the end of the week!

Phew – it turns out there’s a benefit to my usual active obsessiveness after all. But also an even-bigger case for slipping my reading glasses into my wedding suit and never mind lumpy pockets in the photos.

Alright that’s it for a soaring treatise waffly intro this week. Thanks to my email software, I know a select few of you are out there banging ‘refresh’ repeatedly in your eagerness to get your weekly investing reads.

Enjoy, and have a great weekend!

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