The first time you hear a permabear warning of an imminent stock market meltdown – if not of total economic ruin – you’re nervous, and yet also intrigued.
How lucky you were to come across this inside scoop from such an authority!
Perhaps you take even action on the back of it.
The second time you are (usually) somewhat wary. After all, the first time (nearly always) turned out to be a false alarm.
The third time you hear the same doomster warning of a market meltdown just before stocks leg up another 10%, you think: “This guy is an idiot”.
The tenth time you hear him repeat the warning – on CNBC and Bloomberg and in the FT no less – you find a grudging new respect: “He’s no Cassandra, but he’s clearly no idiot. He must know what he’s doing.”
The bare minimum
The persistent popularity and weight given to the views of high-profile permabears is by turns infuriating and confounding to those of us making our way in the slow and less-than-sensational lane.
Eventually we learn that bears get a lot of coverage because bad news always sounds smarter.1
But this still doesn’t explain how easily permabears are forgiven their dire records. However smart they sounded back then, they were still mostly wrong after all.
Well to that point, commentator Sam Ro did everyone a favour with a simple yet convincing insight this week. Writing on his blog TKer, Ro says:
I’ve noticed a pattern in how retail investors rationalize their financial performance after embracing an incorrect bearish view.
It goes something like this: “Well, at least I didn’t lose money.“
This is a simple but brilliant observation.
Retail investors don’t short the market when they get bearish like many pros. They just take risk-off. Either by selling everything or by selling a bit.
If the market goes down, they’re happier than if they took no action.
But if – as it usually does – the market goes up, then they are both ill-equipped and indisposed to calculate the opportunity cost of not maximising their gains by instead taking bear-inspired evasive action.
Ro sums it up with this graphic:
I am sure he’s on to something with this.
But I won’t steal any more of his thunder – please go read the full piece for Sam’s explanation.
Bear necessities
Seen through this lens, other aspects of permabear punditry tactics make more sense, too.
For instance, it explains why permabears are so consistently apocalyptic. They might as well be, because they win so long as their followers do not lose money.
(Remember, their followers are of course missing out on gains. This is huge over time! But our assumption here is it takes a long time – if ever – before the followers get wind of this).
For a bear, being occasionally nuanced about market hunches doesn’t cut much ice.
Firstly it’s only one step up from the most respectable position – which is of course that nobody knows anything, basically.
Hardly something to get you the label Dr Doom.
It’s also ineffective because it fails to cut through the noise. You won’t get labeled – let alone acclaimed – because you won’t be heard or remembered.
For instance, I was – modestly and waveringly – bearish in early 2022, to the extent that I discovered Monevator was being discussed as such on social media and in the comments of other blogs!
It even turned out (lucky me) that I happened to be right to be bearish.
But guess who remembers?
Nobody – most especially I’m sure not those who wrote those comments. (Not even the Monevator regular who memorably wrote elsewhere that were too depressed by reading Monevator at that time, so they had gone to that alternative blog for a cheery pick-up…)
Barely there
Of course I have no aspiration to become a permabear – or anything much more than mildly obsessed active investor with their own website with a few hundred truly wonderful supporters.
But if I was planning to give the permabears a run for their money, then my early 2022 experience was a valuable lesson.
If you going to say the sky is falling, you should really shout it loud that the sky is falling.
And make a diary note to shout it again next year.
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In my case I actually thought that I’d make that observation up myself here years ago. But it seems vanishingly unlikely in retrospect! [↩]
In this latest instalment of our regular series we meet a reader who made themselves effectively financially independent in some distant corner of the world – long before they’d heard of FIRE. Discover how Mark left work to travel on the back of an actively-managed portfolio that continued to grow.
A place by the FIRE
Hey Mark! How do you feel about taking stock of your financial life today?
Great! I’m hoping to demonstrate that a person with a relatively modest income can achieve Financial Independence given time, determination, and a healthy dose of luck!
How old are you?
I’m 59. My partner is a bit older. We have been together since I was 25-years old.
Do you have any dependents?
Once I discovered what I wanted to do with my life, I realised having children was incompatible with the goal of long-term travel. My partner had kids from a previous relationship so was fine with that.
Whereabouts do you live and what’s it like?
We live in a seaside town on the North Sea coast and like it immensely.
When do you consider you achieved Financial Independence and why?
I was never really thinking about Financial Independence as a concept. I just needed to make sufficient returns to finance my life of travel.
When we set off in 2004, my net worth was £210,000. We were spending £10-14,000 per year so I would have been pleased to cover that.
In the event I was lucky to compound my capital over the years to reach a comfortable position, but it could so easily have gone the other way.
What about Retired Early?
We were travelling around the developing world for 14 years. I considered myself a professional investor, but I looked retired to everyone I met.
I still spend hours a day reading and researching investments. But I imagine most of my neighbours think I live on benefits.
Assets: equities and more equities
What is your current net worth?
My net worth tipped over the one million quid mark in 2021, dropped below in 2022, and I am back in a similar position today.
I don’t follow it throughout the year. There were many occasions when I took a kicking during the year only to be fine at the year-end. I don’t think there is much value in obsessing over share prices.
What are your main assets?
My house (8%), shares (89%), and fixed interest (3%). There’s no mortgage.
The shares component is highly-diversified and reflects my biases. I don’t hold any index trackers.
What’s your main residence like?
We own a modest but surprisingly spacious terraced house along the North East coast – bought for £83,000 in early 2019.
Do you consider your home an asset, an investment, or something else?
We were looking for somewhere to settle down.
I don’t really think of the house as an investment because I’m not looking for a return.
Earning: financially unrewarding
What was your job?
I graduated with a degree in Biology in 1984. I had a couple of jobs as a laboratory technician earning modest amounts (£7-12,000) until I took a year out to go travelling from 1990 to 1991.
On my return I took jobs in laboratory management starting at £16,000 in 1991 and ending on £32,000 in 2004, at which point I quit that job to go travelling on a permanent basis (I hoped).
How did your career and salary progress over the years – and to what extent was pursuing financial independence part of your career plans?
I was continually dissatisfied throughout my career, largely because although I was successful in my roles I was unsuccessful in translating this into a decent income.
After taking the year out, my ambition became to save up as much as possible to enable me to go travelling for the long term. I recognised my only chance of doing this was to make money on the stock market. I began to save obsessively and put all the money into a few investment trusts to start with.
Did you learn anything about building your career that you wished you’d known earlier?
Before I started working I assumed that achieving targets and getting results would lead to career progression. It took me a long time to work out that making your boss look good is much more important.
Do you have any sources of income besides your main job?
Since leaving work in 2004 my income has been derived exclusively from cash thrown off by my portfolio through sales, takeovers, and dividends.
Did pursuing FIRE get in the way of your career?
As I said, I never consciously pursued FIRE. It occurred as a side effect of what I was trying to achieve. In fact, I never even heard the term FIRE until I was well into my travels.
Saving: fuelled by frugality
What is your annual spending? How has this changed over time?
When we were travelling we would typically spend £10-14,000 per year between us. At some point my partner’s pension kicked in and she became able to cover her own costs.
We settled back in the UK in 2019 and my personal spend has yet to reach £10,000. Fortunately we don’t have a mortgage or rent to pay.
Incidentally, any tips for would-be global nomads?
A good proportion of the problems we encountered were to do with banking and plastic cards. I’ve arrived in a town to find all of the ATMs out of order or that my bank has unilaterally cancelled my credit card through security concerns.
A digital nomad definitely needs a backup plan in place.
Do you stick to a budget or otherwise structure your spending?
Not at all. I can now afford to do anything I want, but my wants are few and far between.
What percentage of your gross income did you save over the years?
From the point I decided to save as much as I could to when I left work, I estimate my savings rate was about 65% of my net income.
As well as saving out of my earnings I also paid the maximum allowed into a pension and AVC fund1 and had mortgage payments on a house.
I sold the house when we were preparing to go travelling. A few years later I transferred the deferred pension and AVCs into a SIPP with a surprisingly high out-turn, due to declining interest rates.
What’s the secret to saving more money?
I was completely motivated by having a goal. Every spending decision can be framed as “Does this move me closer or further away from my goal?”
That’s not to say we didn’t have holidays and so on. But we didn’t push the boat out.
What about spending less?
I quite enjoyed being frugal and finding new ways to be even more frugal. It can become habit forming.
For example, once I started saving, I virtually stopped drinking alcohol.
It’s important not to take it too far. When we were travelling we would typically be eating out two or three times a day. I was always aware that I was arbitraging costs between the two countries and usually left a decent tip. In the instances where I failed to tip, I would always carry guilt for the rest of the day. So it was better for my psyche to keep it up.
One of my favourite concepts is to become best friends with your future self and then act in their best interest.
What was the psychological transition like going from earning and saving 65% of your salary to spending – even in low-cost countries?
There are loads of psychological aspects of my story that I have pondered, but this isn’t one of them. (I must admit that for my first six months abroad I did wonder what was going on at work.)
We were spending what we needed to on a daily basis, but not much more. There was no point buying more stuff to carry around. Even as I came to feel financially secure in the second half of the period, there was still no need for egregious spending.
I can trace a psychological shift from ‘doing’ to ‘being’. But that is actually very cost-effective.
Do you have any passions or hobbies or vices that eat up your cash?
As a motorcyclist, I have a modest but fun machine that is not expensive to run. I fill the tank every couple of weeks.
Investing: the evolution of a stockpicker
What kind of investor are you?
My intention is to have core holdings of a few investment trusts and then satellite holdings of selected shares. In practice, I always have more ideas than cash so the number of individual shares has multiplied over time.
My approach has changed over the years. I started out buying bulletin board favourites, which worked very well indeed. As I learnt about investing I moved to a Ben Graham value-style which, applied inexpertly, picked up a fair number of value trap losers as well as re-rating winners.
After the GFC2 I developed a spreadsheet method based on Earning Power Value. Filling in the data was very labour intensive, but I learned how to interpret accounts in detail.
The results here were fairly decent. I have never heard of anyone else following this approach as a core strategy, possibly allowing me to have the fabled ‘edge’.
Since moving back to the UK in 2019 I found that I had lost my motivation for data entry and, anyway, my thought process had been moving towards ‘strategic’ positioning for a while.
These days there are a host of reasons to expect Armageddon some time down the track. I have been rebalancing in a defensive direction over the last few years at the expense of my small-cap portfolio. I now find myself to be an increasingly cautious capital allocator, having been far too gung-ho over the years.
I am also aware of the anti-doomsters who forecast a future of abundance. Should that come about I am sure I will benefit along with everybody else. I’m not going to gamble on it though.
What was your best investment?
I bought my first computer in the year 2000, got on the internet, and discovered The Motley Fool website and, in particular, the company discussion boards. I was soon spending a few hours there every evening.
I opened a Stocks & Shares ISA and began buying various bulletin board favourites.
My first three shares were called Emblaze, Geo-Interactive Media, and Soco International. The first two quickly petered out. But Soco International went on to be a 24-bagger3 for me over the next few years. Of course, I was not clever enough to get out at the top but fortunately managed to sell off a decent amount on the way down, between £14 – £17. The remainder provided a headwind to my returns over the next decade. My numbers would look a lot better if I had managed to sell the lot.
The best performer in my portfolio currently is Burford Capital. Unusually, I bought a double allocation to this company at £1.20 when I first looked at it in 2014. This was because I was excited by the clearly compounding business model. From there it rushed up to a high of £20 in a few years. I toyed with the idea of top-slicing for a while but never executed. Then in 2019 a short seller issued a report which caused a deluge of sales, dropping the price to below £7.
I lost over £100,000 before lunch that day. I read the short report and thought it was a bit thin so I held on to the shares. Looking at the graph they bottomed around £3 on the Covid drop and have had a volatile journey back towards £11 today.
Psychologically, I haven’t suffered much from all this as I was following the company rather that the share price.
Did you make any big mistakes on your investing journey?
Where do I begin?
I remember hearing around the time of the GFC that Warren Buffett had never had a total loss. I had already had about five, so I decided I must have been too adventurous. I can’t remember having any more since then – mainly because I’ve got better at selling the losers on the way down.
Whilst investing is about looking to the future, most of my losses have come from putting money into companies where the future looks particularly bright. Even if it comes to fruition, something could well come out of the woodwork so that the investor is not the one to benefit. Lowball offers, political interference, and management greed and incompetence are a few examples.
What has been your overall return, as best you can tell?
I have calculated my net worth annually since I became dedicated to saving and investing. My portfolio now has a 28-year IRR4 of 8.25% with a fair amount of volatility.
With hindsight, I would probably have done better sticking with my original line up of investment trusts. (But then I wouldn’t have the thousands of hours of reading and research to reflect on!)
How do you calculate your returns?
At each year end I calculate my NAV and then calculate the % change over the year – after taking account of my spending – using the XIRR function in Microsoft XL.
XIRR doesn’t work for a negative year, so on those occasions I had to work around a little bit. That might add a slight error.
Note that I am not withdrawing £10,000 to £14,000 spending on top – that’s included in the return calculation. I’ve also added some chunks of capital to the portfolio from when I sold my house and later monetised my company pension.
I put all those annual results into a formula to calculate the geometric mean return (IRR), which comes out as 8.25%.
I know it is Round Number Illusion, but I felt strangely satisfied when my net worth passed £1 million in 2021. I was not surprised to see it drop back a little in 2022. Hopefully it won’t be for long!
How much have you been able to fill your ISA and pension contributions?
Despite having no earned income I’ve been allowed to contribute £2,880 into my SIPP every year since I opened it. I have had a policy of moving value from my trading accounts into ISAs to the extent that I am pretty much 100% tax-free on any returns these days. I’ve never been liable for capital gains tax.
To what extent did tax incentives and shelters influence your strategy?
Only to the extent that they were available, so I used them.
How often do you check or tweak your portfolio or other investments?
I follow the results and reports for all my holdings but I don’t check the share prices except by chance.
When I buy a share I then forget about it until the RNS start coming through. I don’t want to make decisions based on share prices but on company performance.
I do an annual review and at that point I decide where to mould my asset allocation for the forthcoming year. I then keep my eye out for investment opportunities in those areas. I rarely sell positions, so this is more of an incremental course correction that will play out over the years from cash generated within the portfolio.
I also have to take my living expenses from this cash.
Wealth management: steady as she grows
We know how you made your money, but how will you keep it?
I rather hope that my portfolio will continue to gently compound without much input from me. Mathematically, it’s unlikely that the long run result will veer much away from the 8% mark without a few big outlying individual yearly results.
I will continue to develop my portfolio with an eye to reducing equity risk over time.
It’s remarkable how your portfolio compounded even as you lived your dream. I guess you hadn’t heard of the 4% ‘rule’, given FIRE was unknown to you. But did you have any particular thinking on managing cash withdrawals? Or was it all ad hoc?
To be honest I was just hoping for the best. It felt like the right time to be getting on with my plans, but I didn’t know what my spending would be in relation to my pot.
Things were obviously more expensive by 2004 than they’d been in 1990, but still manageable in developing countries. We’d typically pay £11 for a double room, and £5 between us for a main meal.
At first I had the cash from the house sale to spend and invest. By the time that was used up my withdrawal rate was already below 4% (not that I monitored it).
To answer your question specifically, I never had a cash policy. By the time I’d used up the cash reserves, the portfolio was generating enough cash to cover both my spending and capital recycling.
When we left the UK my assets were all in cash and stocks to a total value of £210,000. To risk it all to go travelling at 40 seems foolhardy, seen from today. But you can’t live your life in a spreadsheet!
Fortunately I was completely ignorant of Sequence of Returns Risk, which was considerable at that point.
I thought the main risk was just spending down the capital until the lifestyle became unsustainable. So I’d simply need my stock market returns to cover our ongoing spending over time.
In reality, if I’d got the same returns I achieved but in a less favourable order, then I would have been back and on the dole queue in year two.
So you saw big early wins that enabled you to sustain your traveling lifestyle?
In the early years of travel, I didn’t realise that we were in the late stages of a boom and initially my stock market returns were very gratifying.
At one point in 2007 I was worth half a million quid! Largely thanks to the progress of Soco International. I sold down some of my investment trust holdings and put the cash into small cap value choices.
Then came the Global Financial Crisis. For me it was also a gut-wrenching personal crisis, as my portfolio value tumbled back to where it had started.
My dream looked like it was going to collapse in ruins and I updated my CV to prepare for the worst. But the next year saw a bit of a bounce and by year end 2009 my NAV5 was back over £300,000.
I felt I was still in the game but my confidence was severely damaged. It took about six years to I regain my pre-Crisis asset value.
Has your investment strategy changed with the end of your travels?
These days I’m more concerned about the risks in the markets. I’m moving towards large caps, preservation funds, and even some commodity and fixed interest holdings.
My withdrawal rate has hovered around 1% for the last few years and I still have the State Pension to look forward to – hopefully!
My National Insurance contribution record is somewhat woeful. I’ve bought six years worth of Class 3 contributions and this year I’m experimenting with registering as self-employed to become eligible to pay Class 2 contributions.
Which is more important, saving or investing, and why?
I was a compulsive saver, but a know-nothing investor. In the early years I just chucked the money at the stock market hoping for the best. I then spent 20 years trying to pick winners before I realised that I should really be focusing on building a compounding machine.
In this analogy, savings is the fuel, investing is the engine, and compounding is the outcome. It becomes useful to consider the ins and outs of compounding alongside the factors of successful stock selection.
Do you have any further financial goals?
As I approach 60 I’m a lot more comfortable reaching old age with a secure pot of assets behind me. I would not want to be relying on the government for my future care, so I think financial security in old age is more important than at any other time.
However, it is not as important as living an interesting life on the way there.
Is the hardcore traveling done for now? How do you plan to keep busy for the next 30 years?
When we returned to the UK it felt like ‘turning the page’ on long-term travel. Now I won’t mind if I never go into an airport again.
In my daily life I now struggle to find enough time to do things which were previously on the backburner. I want to focus more on friends and family. And hopefully go hill walking and volunteering on farms.
What would you say to Monevator readers pursuing financial freedom?
Whenever I read articles about FIRE, there is always someone in the comments who declares that it is impossible for ordinary people. What they are really saying is that it impossible for themselves.
It takes time, application, and a fair wind but, barring disaster, the worst that can happen is that you end up with a decent chunk of capital. And you might just end up living your dream!
Not another day at the office: Mark at Machu Picchu on his 50th birthday.
Any other business?
When did you first start thinking seriously about money and investing?
I always had to save up out of my pocket money if I wanted anything as a kid. I guess that set me up well for adulthood when I began to think about my goals.
I made my student grant last throughout the term and into the holidays. I wondered why many of my associates couldn’t manage their funds well enough to prevent running out two weeks before the end of term.
We all had the same grant so, to me, it was simply a case of dividing the grant by the number of weeks of term and aiming to have a bit left over.
Can you recommend any favourite resources?
I currently follow about 200 blogs and websites. It is remarkable how many super-intelligent people are keen to share their thoughts and insights with the world at large.
Some of my favourites are:
Vishal Khandelwal at safalniveshak.com. He distils the common sense lessons from the hubbub of investment noise. A bit of an Indian Jason Zweig.
John Maudlin writes a weekly newsletter, Thoughts From The Frontline, which provides a helicopter view of the developing investment landscape.
Victor Hill at MasterInvestor provides us with deep understanding on a wide array of subjects affecting the economy.
Pippa Malgram has insights on geopolitics which often confound the top-level view.
What is your attitude towards charity and inheritance?
When travelling, we found many opportunities to help people out. We tended to hang around for ages in our favourite places and we were always open to making friends with outgoing local people.
Once we knew them a bit, we would easily notice ways we could help out with their daily lives. Being involved with people on a one-to-one basis is much more rewarding than sending off a donation to a good cause, which we do nowadays.
I can’t claim much interest in thinking about what’s left over though. Having a capital sum in case of care home fees seems prudent. The remainder might well be left to Comic Relief, if I’m the last to go.
What will your finances ideally look like by then?
If the compounding machine works and Armageddon fails to arrive, I expect my portfolio to last longer than I do.
I see some of myself in Mark’s unusual story – I found the Motley Fool just a couple of years before him, and we’re both active investors for our sins – and it does make wonder whether I too might have left the grid a decade ago and ended up in almost the same place. What about you? Questions and reflections welcome, but please remember Mark is a reader sharing his story, not a seasoned blogger. Constructive feedback is fine. Personal attacks will be deleted. See our other FIRE case studies.
An Additional Voluntary Contribution fund enables you to save extra amounts into a workplace pension. [↩]
How do you choose the best bond funds or bond ETFs from the bewildering array of products available?
Many investors find bonds deeply unintuitive – and the asset class’s inflation-fuelled crash in 2022 hasn’t exactly inspired them to dig deeper.
Yet a solid allocation to high-quality government bonds remains the first stop when it comes to strategically diversifying a portfolio dominated by equities.
And that remains true even after last year’s once-in-a-generation carnage, when those hoped-for diversification benefits truly failed to show up.
Interest-ing bonds
It seems like a good time to take a deep breath and a step back.
For UK investors, it boils down to investing in UK government bonds (known as gilts) and/or the government bonds of other developed markets. Such bonds are the likeliest to cushion your equities when stock markets plunge. And that’s just what we want our bonds for. (Equities can deliver the long-term returns – provided we hold on to them…)
We believe the best bond fund vehicles are ETFs and index funds. That’s because their low fees leave more return in the pockets of investors – as opposed to fat-cat fund managers. (See below for more on the ‘ongoing charge figure’, or OCF).
We’ll explain our choices below, but first let’s run through our picks for the best bond ETFs and bond index funds. We’ll do gilts first, and then global government bonds further below.
Source: Fund providers’ data / Morningstar (A dash means data not provided). YTM is yield-to-maturity. ‘Lux’ is Luxembourg.
These are intermediate gilt ETFs and funds because, for most investors, intermediates offer a better balance of risk versus reward than long bonds (far riskier) or short bonds (a miserly reward).
Dedicated long or short bond allocations will be right for some people, though.
You can find more product suggestions in our low-cost index funds and ETFs guide.
There is little to separate the funds in the table. That is just as it should be! Competition between index tracker providers is fierce, so most advantages have by now been eroded away.
You can be confident you’re in the right ballpark so long as you choose a cheap bond ETF or bond fund, with a good track record among its peers.
More on that below. But first a couple of notes about the bond features picked out in the table.
Ongoing Charge Figure (OCF)
The OCF is the annual cost of the product charged to you by the fund provider, as a percentage of your holding. So if you own £10,000 worth of a fund then a 0.1% OCF means you’ll pay around £10 in fees.
Average duration is an approximate guide to how much a bond fund will gain or lose in response to a 1% change in market interest rates.
For example:
A bond fund with a duration of 10 will lose around 10% of its market value for every 1% rise in its interest rate.
The fund’s price will similarly jump about 10% if its rate drops by 1%.
The higher a bond’s duration, the greater the capital gain or loss as its market interest rate fluctuates.
The market interest rate of a bond is not the base rate set by the Bank Of England. The market interest rate is a product of supply and demand for each individual bond on the bond market. If the Bank Base Rate is hiked by 1%, that doesn’t mean every bond will follow suit.
This number will fluctuate as bond prices move. But the main takeaway is that there’s nothing between these products. (Note that when we refer to yield in this article, we’re talking about YTM).
Credit quality
This is a guesstimate of the financial strength of the bond issuer. (That’s the UK Government in the case of the gilt funds in the table above.)
AAA is top-notch while BBB- sets the floor for investment grade. Below that is ‘junk’.
The higher the credit quality rating, the better. It means there’s less chance the issuer will default on payments, at least according to the bond rating agencies.
Bond rating systems and verdicts vary slightly by agency but our main message would be to stick to investment grade.
In other words, don’t touch someone else’s junk.
Bond fund credit quality is the weighted average of all its bonds ratings.
Domicile
Location matters because funds based in the UK benefit from FSCS investment protection. With that you could be eligible for compensation should your investment provider go bankrupt.
True, it’s highly unlikely that you’ll ever need to worry about this provision, especially given the scale of the giant fund shops in our table. But it’s a wrinkle worth knowing about.
Moving on, how have our best bond funds performed this past decade?
We’ve expanded our product scope for this performance check. Partly because doing so illustrates some useful points about bond funds, and partly to again show there’s little to choose between good index trackers.
We’ve highlighted the candidates’ 10-year annualised returns (nominal) within the green box because the longer the timeframe, the more meaningful our comparison.
The cyan lines underscore the main indexes tracked by the best bond funds.
With friends like these…
One thing leaps out immediately from our performance check: bond returns over the period have been absolutely terrible.
A near-zero return over ten years – and stiff losses over tighter time periods – does make you wonder why you’d bother with bonds.
The fact is that unfortunately the entire asset class was smashed in 2022 as interest rates surged and rising bond yields inflicted heavy capital losses.
But counterintuitively, the prospects for bonds are much brighter now that yields are higher (and prices lower).
The reason for this is that bond yields are predictive of future expected returns. If inflation subsides to its historic norm (around 3%) then the yields quoted above would deliver a bond return slightly ahead of its long-term average of 1.4% (real, inflation-adjusted return).
In other words, bonds are now priced to deliver a reasonable return for a defensive asset, even as they also fulfil their primary role as a stock market diversifier.
How things change
When we first wrote this article in May 2021, bonds had delivered excellent 10-year returns but their low yields warned of trouble ahead.
The table below is a nice demonstration of how low yields can correlate with excellent backward-looking returns but auger grim returns in the future.
This representative fund had a terrible yield in May 2021. But its returns over the previous 10-years had been superb:
Vanguard UK Gov Bond Fund
Yield (%)
10yr return (%)
May 2021
0.9
4.8
Sep 2023
4.5
0
Fast-forward to September 2023 and you can see the situation has completely reversed. The yield is healthy again but the 10-year returns are awful (because rising yields cause bond prices to fall).
September 2023’s 0% return over ten years is the fulfilment of May 2021’s low yield prophecy.
Boiled down, yield is the best guide we have to an intermediate bond fund’s expected return over the next decade.
No guarantees, but the asset class’s potential has largely been restored by the bond market dumping that’s burned investors – even as it causes so many to now avoid bonds like sewage on a UK beach.
Here for the duration
Back to our results check. You might look at the table and think the Vanguard UK Government Bond Index fund is the last place you want to be. After all, it’s earned nothing for a decade. And it looks worse than the rest of the field across the other timeframes, too.
Yet the same fund’s 10-year returns were ahead of the pack just two years ago! It’s table-topping performance then – and relegation form now – is mostly due to the longerduration of its holdings.
A higher duration juices your holdings when bond prices rise (and yields fall) but acts as a ball-and-chain when prices fall (and yields rise).
In other words, there’s nothing inherently wrong with either of these Vanguard bond trackers. If prices rise from here then they’ll leapfrog back up the rankings.
That makes the Vanguard pair the best bond fund choice in our table for recession protection, incidentally.
But opt for a shorter duration fund if you think interest rates can only go up or inflation continue to rise – or if you want to dial down the volatility in your bond allocation, even at the cost of some potential gains.
How to compare best bond fund and ETF results
The duration issue helps illustrate why choosing your bond fund isn’t as simple as picking the one that has scored a few extra drops of return at a particular moment in time.
A fraction of a percentage point makes little odds, and it doesn’t tell us which tracker will nose ahead next year or next decade.
Here’s what I’m looking for when I look at the performance table:
Firstly, are any of our comparable bond funds doing something highly unusual? If one product is way ahead of the rest – or completely off the pace – then perhaps it’s not what we think it is. Deviant behaviour is a cue for further research.
In this instance, the trackers are all relatively evenly matched across five and ten years, once you factor in duration differences.
I completely ignore one-year and three-year time periods if I’ve got better data. I never compare funds over one-year anyway. That’s too short to tell you anything meaningful. Longer is better.
Now turning to the indices…
Are our potential best bond funds a good match for their respective index over time? (I’ve underlined the 10-year index return rows in cyan). You’d expect an index tracker to slightly lag its index, after costs.
If a bond tracker is a smidge ahead of, or behind, its index then no matter. But if it lags then strike it off your short list – begone HSBC UK Gilt Index!
You have reason to suspect one index is inferior to another? Then you can sweep its adherents off the table too.
Most intermediate gilt funds follow the FTSE Actuaries UK Conventional Gilts All Stocks index. The Invesco and SPDR Gilt ETFs moon after the Bloomberg Sterling Gilts Index, while Vanguard’s twosome chase Bloomberg’s float adjusted benchmarks.
Here again, the 10-year returns show that the indices are close competitors – with the ‘float adjusted’ index’s shortfall explained by its longer duration holdings.
Where does this leave us?
The sweet spot is getting the blend of features you want from your bond fund at a low cost. It’s only worth factoring in the returns snapshot if one tracker looks consistently superior to the rest.
There’s no point being derailed by minuscule performance differentials if you want a UK-domiciled fund that is available on zero-commission dealing with your broker.
If you’re specifically after a bond ETF (rather than a mutual fund) then the Lyxor gilt tracker is dirt cheap and has edged its index over 10 years. It was second only to the Vanguard UK Government Bond Index fund in 2021, too, despite its shorter duration.
The Invesco ETF is a touch cheaper but it doesn’t have a long-term track record yet.
The 10-year returns of the SPDR Gilt ETF look fine, but it’s twice as expensive as its cheaper rivals. I’d knock it out on that basis because high costs are a proven drag factor.
Finally, the Vanguard trackers are the way to go if you want their extra duration.
Best bond funds and ETFs – Global government bond (GBP hedged)
Source: Fund providers’ data / Morningstar (A dash means data not provided). YTM is yield-to-maturity. ‘Lux’ is Luxembourg.
The choice of global government bond funds and ETFs has exploded since we last looked in 2021. Costs have been slashed by new entrants and there’s even an ESG contender from UBS.
The downside is that only the two older iShares and Xtrackers products have a long-term track record – which is why they crest the table. The Amundi and Abrdn index trackers will notch up three year records shortly, whereas the iShares Overseas fund only launched in August 2023.
Meanwhile, the UBS ESG effort is consigned to the bottom because the Swiss bank hasn’t yet published some very basic information. (Note the blanks in our table.)
Something also seems off about the very low yield published by Abrdn, but that’s the figure it has given. I think I’d rather take a higher yield from one of the other funds, considering they’re not exposing me to much (if any) more risk.
(Incidentally, I’ve had to edit the product names to fit the the table so make sure your choice is badged GBP hedged when you select it from your broker. Some of these funds have unhedged variants but the right product will always have GBP hedged in its name.)
Now let’s do a results check before talking about why you might plump for global government bonds over gilts.
Global government bond (GBP hedged) results check
Source: Trustnet multi-charting tool
Remember, the main objective in comparing results is just to make sure there isn’t a weird outlier on the shortlist. We also want to see if any fund is consistently dragged down by hidden costs.
But the truth is we don’t have much to go on anyway because most of the products are quite new.
What we do know is that intermediate global government bond funds are typically shorter duration than their UK counterparts. That helps explain why they haven’t suffered as much as gilt funds in the sell-off.
Well, that and the fact that interest rate rises have been sharper in the UK.
Global government bonds versus gilts
Diversifying across global government bonds came into vogue in the aftermath of the Great Recession as many countries lost their cherished AAA credit ratings – the UK among them.
As government debt balloons, many investors prefer not to rely on the full faith and credit of their home country.
Strangely, so-called global government bond funds usually hold developed market sovereign debt only.
But that’s actually a good thing because the role of your bond allocation is to lower your overall portfolio risk. So steer clear of global funds that hold much more volatile emerging market bonds.3
What about the underlying indexes? It’s hard to get good information, but factsheets are out there.
As global bond funds are about spreading your bets, it’s worth knowing that the FTSE World Government Bond Index (Developed Markets) is the most diversified by country, followed by the JP Morgan GBI Global Index, and finally the FTSE G7 Index.
On that front, you might ask why would you ever go for a 100% gilts fund4, given the diversification benefits of global government bonds?
Well, you might because the gilt trackers are less costly to own, have a higher yield, and may offer marginally more crash protection to UK investors.
But ultimately that’ll all be cold comfort if the UK state’s finances do eventually go pop. Granted, that’s a nightmare scenario. But it’s also one that once seemed far less plausible than in recent times.
Don’t take currency risk
If you opt for global bonds then make sure you pick a fund that hedges its return to the pound. Doing so removes currency risk from the defensive side of your portfolio, if you’re a UK-based investor.
While currency risk may sometimes be viewed as a positive and diversifying factor for equities, the same is not true for government bonds.
Currency exchange rate fluctuations add volatility to your returns. Government bonds are there to lower it.
Some investors leave their global bonds unhedged. But betting on exchange rates is an advanced move. It’s only justifiable if you really know what you’re doing.
We’ve looked at the mixed bag of evidence for this ploy before in a US Treasuries vs Gilts post.
Don’t sweat the small stuff
From a big picture perspective, any of the index trackers gracing our tables of best bond funds (and bond ETFs) tick the right boxes.
I’ve touched on a few key details to consider. But even those differences will likely prove marginal across many years of passive investing.
The most important investing decision is diversifying between equities and government bonds in the first place.
Choose a competitive bond index fund or ETF as the main brace of your defensive asset allocation and you’ll be on the right course.
Note: Earlier comments below may refer to our 2021 take on the best bond funds. We’ve left them standing for reader interest, but please do check the dates before replying!
There’s something weird about 2023 – which is that nothing bonkers has happened. (Yet?)
I mean just compare the past nine months to last year’s UK mini-Budget mania or Russia invading Ukraine. The pandemic years before that of course. And before that, Donald Trump becoming the US president, or the witless, self-harming, and implausible Brexit.
I suppose we have had the AI frenzy. Which has very possibly put us on course for our ultimate extinction as a species. And even until then, a browser tab on your desktop can now write better than you on almost any subject you can think of, which is pretty crazy. Albeit the output is full of lies.
Then again, so were the Brexit and Trump episodes and that didn’t stop the craziness.
You guys with your pussy-footing are making 2023 feel inadequate.
Four seasons in one day
Most of us don’t remember things being this perma-bonkers in the past.
On the other hand maybe we’re just more aware of the craziness – with newsfeeds and TikTok and viral memes and flashmobs endlessly pumping it all to the surface like an angsty volcano.
But renowned financial writer Felix Salmon argues this is the ‘new not normal’.
In one of five insights from his new book shared by the Next Big Idea Club this week, Salmon writes:
You might think that everything is weirder and more unexpected than it used to be, and you are right. It turns out that with hindsight, there was this very unusual period of calm for about 70 years, from roughly 1945 to 2015. Then 2016 happened, with the election of Trump and the Brexit vote in the UK, there was a rise of unpredictable politicians and movements around the world. After that, COVID hit in 2020. At this point, all of the big post-war structures that were keeping volatility down and making things more predictable had pretty much evaporated. We are now back to what you could think of as “normal” in the 19th century, the 18th century, or even the 17th century. Life was much less predictable in those days.
For most of the 20th century, we lived in a world where someone like Warren Buffett could come along with one big idea and say, “I’m going to make a big bet on America being great, and that one big bet will always be true, and it’s going to make me the richest man in the world.” That is not a world we live in anymore. The world we live in is much more unpredictable, it has much fatter tails, much higher upsides, and lower downsides. We need to be nimbler to navigate it. We can’t just believe one thing that is always going to be true. We’re going to have to update our beliefs, and we’re going to have to get used to a level of volatility, both in terms of climate change, in terms of infectious diseases, and in terms of the economy. That is going to be pretty disconcerting.
The book is called The Phoenix Economy. Given the consistent excellence of Salmon’s output over the years, I might just pick up a copy.
Then again, maybe I’ll re-read Generation X instead. Douglas Coupland’s classic ‘tales for an accelerated culture’ will surely feel sleepy by comparison, and that feels somehow reassuring these days.
