Here’s some handy data on historical asset class returns for the UK. The chart below shows UK asset class returns – with income reinvested – since 1870:

Data in this article from JST Macrohistory1, FTSE Russell, and JP Morgan Asset Management.

As you can see, over the long-term equities (shares) have done much better than gilts (UK government bonds) and cash (here the return on UK treasury bills).

Gilts meanwhile beat cash. But the lead has changed hands a few times – most recently during the 1970s inflation outbreak towards the end of the UK’s biggest bond crash.

A few other things to note:

• The chart shows real historical asset class returns. So the returns strip out inflation, which gives us a more realistic understanding of capital growth in relation to purchasing power.

• The huge 2008/9 bear market and others seem irrelevant on such a long-term graph, yet such corrections are painful at the time and can last for years.

• The lines include divots when all three asset classes trended down simultaneously. Most obviously during the catastrophe of World War One, the 1972-1974 crash, and just last year in 2022. You can deal with this possibility by using an even more diversified portfolio.

• The returns are total returns. That is, you got them so long as you reinvested dividends and interest. If you don’t reinvest income – perhaps because you’re understandably spending it to support a modestly lavish income in your old age – then those stupendous returns come down a lot.

Incidentally, if you’re wondering whether UK historical asset class returns have much relevance to global portfolios, I’d argue that they do.

Firstly, long-run returns of the main UK asset classes are correlated with their global counterparts.

Secondly, few other financial markets can offer such a rich a seam of historical data as the UK’s. Global data is particularly scant before 1970 for equities.

Finally, paying attention to UK historical returns is more pragmatic than relying on US data biased towards the century that the Americans won.

A number of analysts warn that even the US market may struggle to deliver such outstanding results in the future. UK historical asset class returns still rank highly, but are perhaps more reflective of a world in which it’s impossible to pick the winners and losers in advance.

Historical asset class returns: annualised results

Few of us are going to live a century or more (though Gen Z-ers who eat their greens have a decent chance), so let’s break down those historical asset class returns into more manageable chunks:

Historical asset class returns (% annualised)

Note: the longest annualised return available for index-linked bonds is 2.9% over 40 years.

Again, the table shows real total returns – the annual rate at which the asset class grows (or shrinks) over any particular period after inflation – and with income reinvested.

Equities had a poor 2022. But they typically deliver superior long-term returns as the timeline stretches beyond a decade.

However, nothing is guaranteed.

The longest period of negative annualised returns suffered by UK equities was 25 years.

A combination of World War One, Spanish Flu, overhanging war debt – and the financial and social trauma that followed – kept the stock market suppressed for quarter of a century.

Which is why every investor should be diversified, despite 2022’s harrowing fixed income returns that turned the last ten year’s returns negative for gilts and index-linked bonds.

Gilt returns across the decades seem particularly variable, given this is meant to be a relatively stable asset class.

A glance back at the orange line in the first chart shows that government bond returns seem to be subject to long-term super-cycles that correspond to eras of falling or rising bond yields.

For example, gilt yields peaked in 1975 and drifted down thereafter until 2021. That trend of falling yields – and hence rising prices – pepped up bond returns with capital gains adrenaline shots, until 2022’s rapid interest rate hikes ended the party.

Thus, while the historical 50-year return for equities doesn’t look unachievable in the years ahead, we should be probably be much less hopeful about equalling that 3.2% 50-year return for bonds.

Our post on expected returns offers a realistic perspective on the potential of bonds right now.

Finally, cash is often thought of as a safe haven, but it’s delivered the worst long-term returns of all.

Notice that cash has a negative return for the past 20 years after inflation. The end of the low interest rate era has prompted many Monevator readers to switch out bonds for cash. But there can be significant long-term consequences if you take this too far.

Treasury bills as cash proxy – Treasury bills are ultra short-term UK government debt. Academics use the total return of bills as a stand-in for cash interest rates. One reason being that treasury bills are often a big component of cash-like holdings such as money market funds.

Historical asset class returns: the long and short of it

It can be misleading to look at just the last couple of years of asset class returns when you’re deciding how to invest over the long-term.

Returns from asset classes are volatile, so a few years of history gives you no useful information.

Shares may do very well one year and bonds do poorly. The next year the returns may be different, or it may take years before their relative performance changes.

Equally, looking at the long-run, historical asset class return averages can leave you unprepared for the wild swings in fortune regularly inflicted by equities, sometimes by bonds, and once in a blue moon by cash.

But we can get a sense of how tempestuous each asset class is by looking at the distribution of its annual returns. That is, how widely dispersed returns are and how violently they skew towards large gains or losses.

Equities

Annual UK equity returns range widely and wildly – anywhere from -57% to 103%. The positive, overall return of equities is revealed by the right-ward bias of the columns. But low and negative returns are still a frequent occurrence. (Statistically-speaking, we can expect equity returns to be negative every one year in three on average.)

Bonds

The dispersion of gilt returns is much tighter than equities. Lower, positive returns are common, and negative returns quite frequent. But left-tail / right-tail outlier events are fewer and less extreme than in the stock market.

Treasury bills / cash

Finally, here’s why we all love cash. Those steady, if low, returns keep trickling in. Additionally, the chance of a hideous car-crash is minimal.

Different strokes

The historical asset class return distribution charts help illustrate that different assets are good for different purposes:

• Cash is king for short-term requirements. Think paying bills or saving up a house deposit.

• Government bonds are most useful for planning outgoings in 5-10 years. That’s because you can know the return you’ll get in advance, so long as you hold them until they are redeemed. Bonds are also used to dampen down the volatility of your portfolio, according to your risk tolerance. A young and brave investor might hold no bonds. A 65-year old might be advised to have 50% of their money in bonds.

• Shares are best for long-term investing, since they deliver the highest real returns over longer periods. Adding new money regularly, holding for many years, and reinvesting the income can help you manage the volatility.

By owning a simple portfolio of different assets you can benefit from diversification. When one asset class has a bad year another will likely have a good one. As a result you dampen the ups and downs of your portfolio’s value.

Moreover rebalancing can help smooth out the zigging and zagging of the different asset classes.

The price you pay for this reduced volatility is a potentially lower overall long-term return. That’s because your holdings of lower-risk assets like bonds and cash will typically deliver less in the way of gains than shares.

If you’re investing for the long-term into a pension, say, it may make sense when you’re young to pound-cost average into shares alone. Try to ride out the volatility to maximise your returns.

But whatever you do, never take more risk than you’re comfortable with. Always think about your personal risk tolerance.

And remember that a stock market crash can hit you hard if it strikes as you approach retirement.

Returns and tactical asset allocation

A final – and riskiest – option in deciding how to allocate your money is to take a view on what assets look cheap and expensive at any point in time.

You then tilt your portfolio to try to capture a reversion to the mean. That is, you invest presuming that asset classes will tend towards the average historical returns we saw above.

I do this to some extent. But I wouldn’t recommend it unless you’re sure you can avoid following the crowd – and you understand your poor calls could cost you by actually reducing your returns.

Wealth warning: There’s no proven method for forecasting long-term stock market returns. Studies show even the best predictive metric (the longer-term CAPE ratio) only explains about 40% of future returns.

Anyone can see that different asset classes have good and bad years. It’s obvious from tables of discrete annual returns.

But timing when reversion to the mean will happen is very different from just predicting it will happen someday.

Historical asset class returns: a brief history

These things do tend to sort themselves out over time – even if such a reversion feels unthinkable at any given moment.

Just look at the following table from the 2010 edition of the Barclays asset class report:

1899-2009: UK real asset class returns (% per annum)

Source: Barclays Capital Equity Gilt Study 2010

From this table, it’s again pretty clear that different asset classes can deviate from their long-run returns for substantial periods of time.

Moreover equities were showing a very unusual negative real return over the decade to 2009.

As I wrote in the 2010 version of this very article:

UK shares have struggled to advance over the past 10 years, as the markets have been felled by the dotcom crash and the financial crisis.

• You wouldn’t normally expect shares to deliver a negative (-1.2% per year) real return over a decade, or for them to be beaten so handsomely by safe and secure Government bonds.

Over the long term such periods even themselves out, which is one reason why a strong decade for shares may follow the terrible 2000-2010 period.

The FTSE did indeed go on to rally nicely for several years. You did even better with dividends.

Yet in 2009, in the midst of the greatest buying opportunity for a generation – and with the table above showing how badly shares had done for a decade – buying them was not easy.

Take comfort from history

Many people said they had sworn off shares for good by 2009.

But you should never say never again if you want to be a successful investor.

• You might also like my article on US asset class returns.

Remember if you’re using an investment return or compound interest calculator then it’s legitimate to use long-term historical returns as a proxy for the interest rate function in the calculator.

Note: Comments below may refer to a previous version of this article, so please check their date.

1. 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. [↩]

What caught my eye this week.

One of my least favourite articles on Monevator is the stab I had at explaining Lifetime ISAs.

In fact it was my second stab. I’d updated an even flimsier first effort just a couple of years later.

But I’d left a 2,500 word version 3.0 unpublished. Mostly because I felt it needed another 2,000 words to be comprehensive. And did anyone want to read that?

My published take is not a terrible article. But it doesn’t do a truly great job at explaining why the Lifetime ISA is a terribly confused addition to the ISA lineup.

And there are now better articles out there explaining exactly who might want to use a Lifetime ISA. Complete with the couple of dozen or more caveats and complications that such an article requires.

Fleas on fleas

My Lifetime ISA excursions triggered a bit of a crisis of confidence at Monevator Towers.

How comprehensive could or should we try to be?

We have perhaps the best reader comments on any financial site in the UK. And I knew that regulars would (constructively and rightly) point out the gaps in my explanation.

I didn’t mind that – indeed I welcomed it – but I also knew I’d be a bit miffed by some of them. That’s because it’s hard to explain how one-size-fits-nobody once you get beyond the basics of personal finance and investing to someone who hasn’t tried giving the complete picture themselves.

You need to write about something – whether ISAs or particle physics – to see that very often, the one thing you believe is of most importance is very often somebody else’s superfluous detail.

The Lifetime ISA experience ultimately nudged us towards doing fewer and deeper articles – especially for my co-blogger – and I feel we lost some of the breezy accessibility of an earlier Monevator in the transition.

But that’s the trouble with knowledge. The more you know about something, the more you’re aware of all the edge cases, contradictions – and everything you don’t know.

It was easier to write Monevator 15 years ago when we had less to share but didn’t really appreciate that. Knowledge is labyrinthine.

For whom the bell tolls

Anyway this isn’t all just me getting the tiny violins out about the hard lot of being a blogger.

It’s more a rambling Bank Holiday prelude to say I have sympathy with Andy Bell’s views on ISAs, which he’s been floating in the media recently.

Bell – the founder of the SIPP platform that carries his name – told the Financial Times this week that his company proposed:

…scrapping separate cash and stocks and shares Isas to create a single new offering.

It also wants to reform the Help to Buy and Lifetime Isas, which offer a tax-free bonus to people aged under 40 saving for a home. The platform is also urging the abolition of the Innovative Finance Isa, a type of peer-to-peer loan.

Bell said plans had been presented to chancellor Jeremy Hunt and reflected an ambition to simplify Isas to motivate savings and investment.

While he acknowledged the plans could narrow consumer choice, he insisted that the range of products currently on offer were too complicated.

“The proliferation of Isa products worries me. If you’ve got six Isa products to choose from, you almost give up,” said Bell. “If you were starting with a blank sheet of paper you wouldn’t design what we’ve got today.”

As somebody who did my time in the trenches on the ins and outs of various ISA products, I agree.

It’s true that a Monevator maven – someone who reads every article and pulls us up on our errors and omissions – no doubt enjoys nothing more than shifting from optimal savings product to tax-efficient vehicle to tax defusing like a freestyle skateboarder doing tricks.

I’m one of those too.

But in the profusion of ISA types, the average person just sees more jargon layered on top of the already murky world of saving and investing. And they have a point.

Ideally we’d have just one kind of savings account. Flat tax relief at 30%. With some curbs or outright restrictions on withdrawing and replacing all the money, to incentivize saving for old age. But those guardrails as clear as possible too.

The complexity we have today in ISAs and pensions1 is more a result of politicians looking for rabbits to whip out of hats – or sneaky opportunities to take back what they gave us before – rather than joined-up thinking.

True, simplified ISAs would do Monevator out of a few opportunities for articles. But after my experience with the myriad (don’t-) use cases for the Lifetime ISA, I’ll live with that.

Have a great long weekend!

[continue reading…]

1. Especially with the recently abolished Lifetime Allowance. [↩]

There are many things that make Warren Buffett remarkable, as you’ll know if you’ve read his biography The Snowball.

There’s his appetite for junk food, and how his first wife chose his second.

There’s his longevity – Buffett is still happily working at 92.

And there’s the fact that there’s no Warren Buffett Hedge Fund.

Instead, Buffett’s investment vehicle Berkshire Hathaway was born out of nearly a dozen partnerships that Buffett first created and ran for family and friends.

When these partnerships were wound up, most of the partners rolled their money together with his, on equal terms as shareholders. They were then made fabulously wealthy over the decades as the greatest investor ever compounded their shareholdings to the moon.

Buffett’s investing and business activities made Buffett rich, too.

At his peak in 2008 – before he began giving his money away – Buffett was the richest person in the world. His fortune stood at $62bn.

By 2023 Warren Buffett was merely fifth on the Forbes list, overtaken by upstarts like Jeff Bezos and Elon Musk.

But don’t worry! Buffet’s net worth has still nearly doubled since 2008 to $106bn.

The Buffett Hedge fund that wasn’t

All this success was a win-win scenario for Buffett and his partners, you might think.

But it still wouldn’t be good enough for a hedge fund.

While hedge fund fees have come down in recent years, these funds historically charged 2% annual fees for managing your money, as well as taking 20% of any gains. As a result they devour their investors’ returns.

Just how much could you lose from such high fees?

Terry Smith – the fund manager sometimes touted as the UK’s answer to Buffett – once did a worst-case analysis of hedge fund fees versus Buffett’s first 45 years as an investor.

Smith found1:

Warren Buffett has produced a stellar investment performance over the past 45 years, compounding returns at 20.46% pa.

If you had invested $1,000 in the shares of Berkshire Hathaway when Buffett began running it in 1965, by the end of 2009 your investment would have been worth $4.3m.

However, if instead of running Berkshire Hathaway as a company in which he co-invests with you, Buffett had set it up as a hedge fund and charged 2% of the value of the funds as an annual fee plus 20% of any gains, of that $4.3m, $4.0m would belong to him as manager and only $300,000 would belong to you, the investor.

And this is the result you would get if your hedge fund manager had equalled Warren Buffett’s performance.

Believe me – he or she won’t.

Let’s repeat that money shot. After 45 years, the Berkshire The Counterfactual Hedge Fund would have turned $1,000 into $300,000 for its investors. Which actually isn’t bad.

But it would have generated $4m for manager Warren Buffett.

How the Warren Buffett hedge fund rankled

Smith’s analysis has been criticised because a hedge fund wouldn’t usually reinvest the 2% management fee back into its own fund and compound that over time.

And it’s this compounding of the fees that really drives the huge gains for the would-be Buffett hedge fund in Smith’s example.

But I don’t agree with this criticism. Buffett’s own record sees all invested money compounding at 20.46% over the time frame, so it seems reasonable to assume the fund does the same to make a comparison – even if in reality hedge fund managers would spend their fee money on Monaco bolt holes and Lamborghinis.

Another criticism is Smith assumed the hedge fund always gets its 20%, whereas in reality there would be a high water mark. This means in years where the hedge fund underperforms, it would ‘only’ get its 2% management fee – until the portfolio breached the previous high.

As far as I can see this is a mathematical shorthand though. (Unless you’re prepared to download Buffett’s returns every year and plug those into a hedge fund modelled on the 2/20 structure.)

Buffett did and they didn’t

On balance, I think Smith’s point is well made. Not least his throwaway last line – about whether your hedge fund manager would match Buffett’s record.

Don’t hold your breath! Even back in 2010 the average hedge fund was delivering the same performance as a simple basket of index-tracking ETFs. Such vanilla ETFs typically charge less than 0.5% a year.

There are certainly a handful of stellar hedge funds out there (which you and I mostly can’t invest in) that justify their fees.

But as a class, in the past decade the track record of hedge funds has only gotten relatively worse since Smith did his analysis.

Study this table of returns from respected commentator Larry Swedroe:

Swedroe comments :

Over each of the one-, 10- and 20-year periods, hedge funds destroyed wealth because their returns were below the rates of inflation.

Over the last 20 years, hedge funds barely managed to outperform virtually riskless one-year Treasury bills, and they underperformed traditional 60% stock/40% bond portfolios by wide margins.

Hedge fund defenders typically retort that it’s not fair to lump all hedge funds together like this.

And as I note above, it’s certainly true that some funds have delivered extraordinary gains to investors.

However by the same token some individual stocks have done well, and some markets tracked by certain index funds have smashed others.

So that argument doesn’t really hold water for me.

Another push back is that many hedge funds don’t aim to beat the market. Rather they offer diversification and hedging benefits by following alternative strategies.

Again, I’m not massively persuaded – at least not enough to get the whole pseudo-asset class off the hook.

As Nicholas Rabener at Finominal noted recently, hedge funds tend to be more correlated with market downside than the upside – a very undesirable characteristic. In Rabener’s analysis, investment grade bonds offered superior diversification.

Swedroe also shoots down the counterarguments before concluding:

Why have hedge fund assets continued to grow and why have investors ignored the evidence?

One possible explanation is the need by some investors to feel ‘special’, that they are part of ‘the club’ that has access to those funds.

Those investors would have been better served to follow Groucho Marx’s advice: “I wouldn’t want to belong to a club that would have me as a member.”

Another explanation is that investors were not aware of the evidence.

Full disclosure: Buffett’s returns – as represented by the growth in Berkshire’s share price – have slipped in recent years, too.

I mean, as per his 2022 letter Berkshire’s compounded annual gain from 1965 to 2022 is now a mere 19.8%. That’s versus 9.9% for the S&P 500 over the same time period.

(I’m being facetious. Berkshire’s return is bonkers, equivalent to an overall gain of 3,787,464% since 1964.)

How to make $81 million before you’re 40

Returning to Warren Buffett, you might ask why if he’s so smart did he not start a hedge fund instead?

There were plenty of active funds in existence by 1965. Buffett’s first employer, Graham Newman, was essentially a hedge fund.

Well, the answer is – Buffett did!

In the days before Berkshire Hathaway, Warren Buffett ran his partnerships I mentioned along hedge fund lines. Yet even these weren’t run following the 2/20 standard of hedge funds.

To quote Buffett from The Snowball:

“I got half the upside above a 4% threshold, and I took a quarter of the downside myself. So if I broke even, I lost money. And my obligation to pay back losses was not limited to my capital. It was unlimited.”

Normal hedge funds fees take no punitive hit in negative years, so Buffett was again doing things differently.

Also, Buffett then did exactly what critics of Smith’s calculations say no hedge fund would really do. He reinvested the fees he drew from his partners back into the partnerships, compounding his share of the capital year on year.

Like this, between 1956 and 1967 Buffett increased his net worth from $172,000 to over $9 million.

That’s well over $80 million in today’s money. Buffett earned it by the age of 37.

This was how Warren Buffett first got rich.

Don’t bank on finding another Buffett

Buffett’s supreme confidence in his investing techniques and a favourable market meant he never took the downside of his unusual fee structure. There were no years where he made less than 4%!

The legend of Buffett might be very different if he’d had a bad year. We’d probably never have heard of him today if he’d had a few bad years in a row.

Perhaps Buffett, too, had realized this by the 1970s. That was when he wound the partnerships down and instead lumped his money in with that of his faithful investors to co-own the collection of companies that became the modern Berkshire Hathaway.

These first investors and those that later bought Berkshire stock were fortunate Buffett didn’t foist 2/20 fees on them. They were made immeasurably wealthier by being on the same terms in Berkshire.

Yet I suspect from my reading of Buffett that he’d say luck had nothing to do with it. They were his partners, not his clients, and it was having their backing that enabled him to act with the confidence and boldness that has defined his long career.

The bottom line: There is no Warren Buffett Hedge Fund because while he is an implacable acquirer, Buffett doesn’t think like a hedge fund manager. He thinks – and always has thought – like a business owner, and a shareholder.

The other bottom line: avoid high fees like the plague. Most people should use index funds instead.

(If you don’t believe me, believe Buffett!)

1. Terry Smith has closed his blog where his article was first published. I’ve linked to an Investment Week report on this maths above. [↩]