What caught my eye this week.

Will house prices fall, steady, or crash? I’d say a decline was the consensus view as we closed the door on 2022, with memories of Liz Truss still swirling about the porch like a frightful CGI spirit.

Yet having competent technocrats back in Downing Street after a multi-year hiatus has had such a calming effect on markets that the prospect of a proper slump seems to me to be abating fast.

PM Sunak and chancellor Hunt still can’t offer much in the way of growth. And that’s a problem in the long-term.

But even the slow puncture Brexit economy doesn’t seem quite so bad after October’s multi-lane pile-up.

Choose your poison

The major reason that if we’re going to economic hell in 2023 it’s on a Stannah Stairlift not a handcart is lower mortgage rates.

Declining swap rates had suggested there was room for lenders to reprice their mortgages cheaper if they wanted to play for market share.

And happily for anyone needing a mortgage, they’ve done so.

Massive lender Nationwide is the latest to cut rates across the board and join the sub-4% five-year fix club. Recent Weekend Reading links have flagged previous entrants including Virgin Money, Natwest, HSBC, and the Yorkshire Building Society.

Hardly universal, but far better than average five-year rates above 6% following the Mini Budget.

Getting the best rates does typically require lower loan-to-value ratios of 60% or less. Across the spectrum, lenders seem to be being more judicious about who they lend their cheapest money to.

Whether you’re buying or remortgaging, putting in a little extra cash might save you a lot of money if it unlocks a cheaper rate band.

Resetting the game

For sure lenders aren’t chucking money around like its confetti again. The days of less-than 2% five-year fixes have gone, at least for the foreseeable. Hence the froth is coming off the pandemic-era price pop.

But while employment remains strong – and with many of those who are leaving the workforce apparently doing so because they can afford to, to the dismay of the chancellor – it’s hard to see rates at today’s more reasonable levels being a catalyst for a ginormous crash.

Maybe we’ll even stumble into what the UK economy both needs and fears – stagnant prices.

More young people would then get a chance to move out of the chillingly expensive rented sector sooner, and start building housing equity instead.

Inflation will have to abate though for the economics of stable prices to work for home builders, if we’re to avoid the knock-on of even fewer new homes being built. Workers are too scarce now for a big government house building program. We need to the commercial sector to keep at it.

And of course mortgage rates could start to rise again. The US stock market wobbled this week as various economic stats have suggested it will be longer before interest rates can be cut there.

Rates remains the greatest guessing game in town. Which is very unfortunate for anyone having to make long-term choices about paying for the roof over their heads.

But everyone would suffer in a big slump, and after the past few years we can do without one.

Have a great weekend!

[continue reading…]

Welcome back to the Monevator snug! Settle in for another interview with a reader who has achieved financial freedom (aka FIRE). This month we learn how moving to a cheaper part of the country – or geo-arbitrage – enabled Jake’s young family to live their dream.

A place by the FIRE

Hello Jake, how do you feel about taking stock of your financial life today?

It’s the first time I’ve publicly discussed our story. I’m a little nervous and excited. I’m also happy that hopefully I can give something back to the FIRE community.

How old are you?

My wife and I are both in our mid-40s. We’ve been married for 16 years.

Do you have any dependents?

Two children who are both at junior school.

Where do you live and what’s it like there?

During 2020 we relocated from the Home Counties to East Anglia.

It was a big decision and move for us, as our children had to leave their friends behind and start again at new schools. It was difficult at the time with the lockdowns and schools closing. Thankfully they’ve settled in well.

The move was a lifestyle choice. My wife and I agreed we would like a slower and more relaxed pace of life, so we could spend more time with our children. It was also part of our FIRE strategy – specifically, domestic geo-arbitrage.

Property prices and the cost of living are lower in East Anglia than in the Home Counties.

When do you consider you achieved Financial Independence (FI)?

Using the 4% rule as guidance, we reached our FI number during 2022. That’s based on living costs of between £34-35,000 a year, suggesting a required net worth of between £850-875,000.

Of course, our net worth can fluctuate by large amounts on a monthly basis. But so far, after every big dip the market has recovered enough for us to remain comfortable with our plan. We’re aware this may not always be the case.

There is also the mental side to consider. Self-doubts as to whether we have enough. The nagging feeling that we could do with a little more, and a little bit more after that.

It can be scary – even overwhelming. You question if you have made the right decisions.

How do you deal with such doubts?

We try to block out as best we can the external noise and not compare ourselves to others.

At some stage you must take action based on your circumstances. Otherwise progress will not happen, and you will continue being fearful.

We feel we are in a good place and have enough. We’ve talked about the need for us to be fluid, and adjust if required.

Did you retire when you achieved FI?

I left employment towards the end of 2022 and currently have no intention of returning. But that is not to say that I will never work again. One day I may find a part-time role that suits me.

After I discovered the FIRE community in 2017, my wife and I discussed how we wanted our future to look. I was commuting into London daily and was physically and mentally exhausted and frustrated. For a long time I had wanted out of the rat race. The discovery of the FIRE community was a glimmer of hope.

I find it strange to label myself retired. I dedicated a lot of my energy to the Financial Independence part of FIRE. The retiring early part is an option that becomes a real possibility if you wish.

I had become disillusioned with my employer. Reaching our FI number when we did in 2022 allowed me to end that relationship. It can be hard to take a step back and understand how unhealthy a work situation is for you and your family.

Assets: overweight America

What’s your net worth?

Our net worth is £874,500; additionally our house is valued at £475,000.

How is it comprised?

• Two ISA accounts (invested in S&P 500 passive index funds) £175,000
• Two ISA accounts (invested in a UK bank) £119,000
• Two taxable general trading accounts (invested in S&P 500 passive index funds) £128,000
• Three pensions (two are SIPPS invested in S&P 500 passive index funds) £441,000
• Cash and Premium Bonds £18,500
• Debt is on a credit card (charging 0%) -£7,000
• Total net worth (excluding house) £874,500
• Total net worth (including house) £1,349,500

Your allocation towards the S&P 500 jumps out…

Our investments are not as diversified as is usually encouraged in the FIRE community. It could be argued though that the bigger companies in the S&P 500 have operations worldwide. Thus a reasonable percentage of the revenue and profit is diversified.

But why not a global tracker?

It was probably partly the influence of the American FIRE blogs that I spent time reading when we started investing in passive index funds. I also wanted to avoid any more exposure to the FTSE 100 as we had our investment in the UK bank.

For some unknown reason I am not attracted to the European markets.

Through my research the S&P 500 appealed on many levels. The large global companies, the high global market share, the strict regulation, the global revenue exposure, the historical returns. I also think that the American markets have a very good reputation worldwide.

Rightly or wrongly, I arrived at the conclusion that American companies are diversified international companies with global reach. But I am not closed to the idea of a more traditional approach to diversifying. I’ve been thinking about moving some money into a global tracker in the future.

What about that single company holding?

A legacy holding built up over many years before we discovered the FIRE community. It’s a bank that pays out dividends, which we automatically re-invest.

As it’s in an ISA we don’t have to worry about the dividend allowance.

You have no mortgage…

We own our home, and it is mortgage-free due to our domestic geo-arbitrage. We sold our house in the Home counties for more than the purchase price in East Anglia.

Do you consider your home an asset, an investment, or something else?

This is a more complex question than it initially seems.

There are a lot of people who consider their home an asset. Some even refer to it as their pension. I guess the definition is in the eye of the beholder.

In my opinion it’s a mixture of all the above. It is partly an asset, as it has a value – the price that someone is willing to pay. And in our case there is no mortgage.

As an asset it is not immediately liquid. The selling process will normally take a couple of months, at least. But you can realise the value once it’s sold.

On the flip side it costs us money on a monthly basis via council tax, electricity and gas, water, broadband, and general upkeep.

We don’t include our home in our net worth when we calculate it every month.

Earning: doing it the hard way

What was your job?

I worked in the commodities industry and my wife in the fashion industry. We both had various roles in different industries over time. Neither of us had clear career paths.

What was your annual income?

When I finished at the end of 2022, it was a base salary of £68,000 plus a yearly bonus, which varied between £3-5,000.

My wife gave up work approximately eight years ago, when we had our second child. She was earning £24-25,000. We lived on a single salary after that as a family of four.

How did your career progress – and was pursuing financial independence part of your plan?

I’ve worked full-time for 24 years, but it was only for the last 12 years or so that I earned over £40,000. Before that I earned between £12-30,000.

My most important career move was when I moved within the same industry but to a different department. That increased my salary by £10,000. It was huge to us – going from £30,000 to £40,000. I’d been trying to make the move for several years, both internally and externally. But it was very competitive and my employer placed a lot of new graduates into the role I was aiming for.

Fortunately, I persevered. I found out an external company was looking for someone in the role that I wanted. Interestingly, I’d interviewed there previously. I contacted the person who interviewed me the first time. This time I was offered it. Looking back it was a pivotal point on my way to a higher income.

Intentionally pursuing FI only became our plan in 2017, so it did not affect my career.

Did you learn anything about building your career you wish you’d known earlier?

In the first half of my career, I had to be very patient regarding progressing into higher-paying roles.

I switched industries a few times – mostly for potentially higher earnings. The tradeoff I discovered was that with higher earnings came higher levels of stress and pressure. Having to deal with volatile, aggressive and sometimes untrustworthy individuals higher up in the food chain.

I struggled with this more once we became parents. I felt guilty that I was not spending as much time at home with my family. Even when I was there physically, mentally I was consumed by work.

I wondered if I should have worked for myself rather than a corporate machine. If I had my time over again, I would probably either try working for myself or be more intentional at the start of my career.

In the first ten years of my career, I had more energy, motivation, and desire. I would have been better suited to working longer hours then – to arrive at a certain level before I became a father.

Do you have any sources of income besides your main job?

No. We did raise some extra cash to invest by de-cluttering our home and selling unwanted items online. Almost £2,000 after costs.

Did pursuing FIRE get in the way of your career?

It didn’t get in the way, but I was spending a lot of time thinking about it and researching.

After discovering the FIRE community, I spent months reading the different FIRE blogs. There was so much information, amazing content, and thought-provoking ideas. My head was spinning. I was in a daze, I could not stop thinking about this amazing discovery. I had found like-minded individuals, who had a similar mentality and way of thinking.

This community wanted to save and invest in an optimal way, working towards a better future – a flexible one with choices. I had been trying to do it my own way for years, with mixed success.

Saving: Automatic achievement

What is your annual spending? How has this changed?

We have tracked our expenses over many years.

Our annual spending has crept up a little. Based on our 2022 expenses – the highest we’ve had, and what we expect to maintain – we require between £34-35,000 per year.

This includes a little bit of wiggle room for price increases or an unexpected bill or two.

Do you stick to a budget?

We have a good understanding of where our money goes. We don’t have a specific monthly budget, but we’re aware of our spending habits. We will know how we are doing as the year progresses.

As a family we have never been extravagant with our spending and have always made sure that our basic needs are taken care of first. In addition, we make sure our children have opportunities to learn and enjoy different activities. We sign them up for after-school activities and trips, and pay for them to follow their interests and hobbies. They enjoy birthdays and Christmas.

We very rarely make impulsive purchases. If we decide we want something, we research prices and sometimes wait until the item is on sale or we can purchase a slightly older model.

Occasionally after waiting patiently, we decide we do not need it!

What percentage of your gross income did you save?

I didn’t track our savings rate early on. Even when I attempted to, I wasn’t sure I was doing it correctly. I was unsure whether to include my employer’s pension contribution, and the mortgage repayment after interest.

After some conflicting research, I settled on a calculation method.

I’ve had a look through some old spreadsheets, and it appears our saving rate was around 60%. I would guess even in the earlier part of my career my savings rate was approximately 50%.

Impressive. What’s your secret?

I’ve always been good at avoiding impulse purchases. Also, I automated savings and investments. These would be taken from my bank account when I received my monthly salary.

I didn’t consider that this was money available to spend. It was taken like tax.

Do you have any hints about spending less?

I believe mindset is very important when it comes to cash management. It may be you become bored or impatient easily, or you fear missing out. Try to learn to be disciplined and strategic. Put a basic budget in place. Automate, and avoid impulsive spending.

Do you have any passions, hobbies, or vices that eat up your income?

I’ve been slowing reacquainting myself with fishing. I still have a lot of equipment from my youth and I purchased a few secondhand items. So currently it’s not costing me too much.

I hope to find some new interests now I have more time. But surprisingly so far it hasn’t felt like I have had much! Our days are still structured around the school runs.

Investing: pick up a pension

What kind of investor are you?

Originally I was an active investor through individual companies and active funds. There was not a great deal of transparency regarding the fees. I was not aware of passive index investing.

Now most of our investments are in index funds. We are still invest in the one individual company, but have not made any additional purchases for years (except for the dividend re-investment).

What was your best investment?

One oil company share I made a profit of £9,000 on years ago. I am not sure I could classify it as an investment as it was short-term. I didn’t have a well thought out investment strategy back then.

My investments in my pension have probably been my best long-term decision. Especially when you consider the employer contributions, the tax relief, and the years of compounding still to come.

Did you make any big mistakes on your investing journey?

My biggest and most costly mistakes were investing in individual companies.

At the beginning I was influenced by day traders and the potential profit that could be made quickly. I read article after article about oil companies. The money they could make, the new discoveries of oil fields all over the world, and the expected oil reserves each field could contain.

Even though I made a profit out of one, I lost a lot more on the other companies I invested in. It taught me a valuable and expensive lesson.

I always remember losses much more than any profits!

What has been your overall return?

I didn’t track or record percentage returns. I have partial records that I have pieced together from the first part of my investing journey. I made a profit on my active managed funds that were in an ISA, but losses on most of the individual companies. I calculate I made an overall loss during this period of around £10,000.

At the same time, I also had money in premium bonds and savings accounts, I had started paying into a pension, and we had taken out our first mortgage – which we overpaid on each month.

Did you fill your ISA and pension contributions?

I’ve invested in ISAs since early in my career. Most years I was not able to use the full allowance. We also sold a large portion of our ISA investments to help with an earlier house deposit.

In the last few years we have used our full allowances. Our domestic geo-arbitrage house move enabled us to do this with the money that was left over. The rest is in our taxable trading accounts.

In my first few roles I didn’t have a pension, so I didn’t start as early as I should have. But over the last 15 years I have invested heavily in my pension.

I couldn’t contribute the full allowance of £40,000, although I was able to increase my contributions for a few previous years via the carry forward rules. I normally contributed between £15-22,000 a year, including employer contributions.

My wife has a small pension from her time working. In recent years we’ve invested £3,600 a year in it. (That’s the allowance for a non-taxpayer, including the tax relief received).

Did tax influence your strategy?

It played a major role once we truly understood the full tax incentives on offer with a pension (especially for a higher-rate taxpayer)

In the last six years of my career, I increased my pension contributions every year. Including the employer contribution, it was 33% of my salary by the end.

We also invested in our ISAs where possible.

How often do you check or tweak your portfolio or other investments?

We track our net worth once a month via a spreadsheet. Occasionally I’ll check certain parts more often.

I have a further spreadsheet split into pre and post access to pensions. This models different growth scenarios for our investments. For example, a low assumption of 2% average growth per year – up to 7%. I also include the withdrawal of our living costs as part of the calculation in the same forecasts.

It’s not perfect but it gives us a starting point, allows us to see how we’re progressing, and assists with forecasting. Hopefully it will flag any potential issues so we can be pro-active if needed.

Wealth management: dealing with de-accumulation

We know how you made your money, but how did you keep it?

As my salary grew, we tried not to give into lifestyle creep. Bonuses were normally invested as lump sums.

One intentional tactic we implemented from our very first mortgage was to overpay every month. We continued with every mortgage we had. This enabled us to build up a large amount of equity and pay less interest, as we reduced the term of our mortgages with the overpayments. I understand this was at the opportunity cost of investing that money in the markets.

Also, as mentioned previously an important part of our FIRE strategy was domestic geo-arbitrage.

After we relocated, the money left over was invested in passive index funds. We made a lump sum payment into my pension, using the carry forward rules. We also transferred some older pensions from higher-fee companies into SIPPs with lower fees.

I continued to work from our new home until the end of 2022. Those two and half years of working from home saved us around £10,000 on commuting costs.

We decided to spend money on our new home from my salary, before I left work. This way the large, planned-for costs were paid for while I had a monthly salary.

Which is more important, saving or investing, and why?

They are both important. I’ve placed more importance on investing. But it must be the right type of investing for your own circumstances.

Long-term investing is key so that you benefit from compounding. You need to be disciplined and patient to see the rewards. It’s probably best to get into the mindset of forgetting about the money invested – especially if you are young, with a passive index tracker – so you’re not tempted to fiddle. This is how I approached paying into my pension.

Was financial freedom a goal with a timeline?

I always had a dream of some form of financial freedom in the future. A desire to break away from the path much-travelled. But I was unsure if and how this was achievable, until I discovered FIRE.

I made plenty of mistakes in my younger years. I was lacking relevant knowledge, direction, and intentional decision-making. These missing components are exactly what the FIRE community has provided me with, and so much more. Once we came up with our FIRE plan in 2017, I was hopeful of achieving freedom before we were 50.

For us the pivotal part of our strategy that allowed us to reach financial freedom by our mid-40s was domestic geo-arbitrage. This unlocked the home equity we had built up.

Can you share more of your thinking on your domestic geo-arbitrage?

I realised we would need to release the large amount of equity we’d built up in our house in order to be financially independent before we were 50.

I’d read about international geo-arbitrage, but we wanted to stay in the UK. My wife and I discussed the possibility, and we were both open to a new adventure and lifestyle.

We started by considering cheaper areas or houses in the Home Counties. But we were unable to find anything in the right price range that would work for us.

It was at this point I mentioned the possibility of East Anglia. As a boy I use to spend some time with family that lived in the area. I had very fond childhood memories – maybe slightly rose-tinted – and suggested it might be the right place to start our new life.

We did a lot of research online and came up with a list of potential areas. My wife and I visited these areas and later took our children along. The rest, as they say, is history!

Working from home really helped with the transition, as I was not wasting hours a day commuting. This allowed me to be more involved with our children.

We did move further away from family and friends, but fortunately they come and visit. We have also made new friends, mostly with other parents.

There is not anything else we miss from our old life. We’re looking forwards rather than backwards. Now that I’m no longer working, we can slowly piece together the lifestyle that suits us.

Did anything unexpected get in your way?

The biggest challenge was the psychological aspect of re-locating our family to a new area away from family and friends.

Looking back our worries were unnecessary. It is easy to say that now, but it turns out our children are very resilient. They just got on with it!

How are you de-accumulating your pot?

The de-accumulation stage is a scary prospect when you’ve spent so much time saving and investing. It feels like an unnatural shift in mentality. One that I’m not completely at ease with yet.

We’ve split our costs into two sections. Costs that have to be paid out of our bank account by direct debit – council tax, electricity and gas, water, costs for children’s activities – and all other costs that can be paid for by credit card.

This is because we have some 0% interest credit cards that don’t have to be paid back until 2024.

We have enough cash for approximately 16-18 months’ worth of costs. These are paid out of our bank account by direct debit. Most of this cash is in an easy access savings account paying interest of 2.75%. When we need to top up our bank account, which will be on a monthly basis going forward, we will transfer some cash from the savings account.

I believe this strategy – earning interest on cash we’ve saved and using 0% credit cards that are not charging interest – is called ‘stoozing’. The 0% cards will be paid off by selling units of our funds.

Sequence of return risk is a danger. We plan to sell some units of our funds from our taxable general trading accounts by the end of March 2023 (for the current tax year). We will then re-invest this money to utilise our ISA allowances for the new tax year, starting in April 2023.

We’re also planning for the reduction in the Capital Gains Tax (CGT) allowance over the next few tax years. We’re considering selling more units of our funds from our taxable general trading accounts by the end of March 2023. There is a strong possibility we may be selling these additional units of our funds at a lower price than we would have wanted.

Any cash raised will probably be split between savings accounts and premium bonds, until we can use it for the next tax year’s ISAs or to pay off the 0% credit cards or our living costs.

Do you have any further financial goals?

We may have to help our children financially in the future, so we’d like to maintain or even grow our pot as best we can.

It’s a fine balancing act, and we don’t have all the answers. It’s like being a parent. You do the best you can and adapt to the circumstances.

What would you say to Monevator readers pursuing financial freedom?

Monevator readers are very knowledgeable, and share interesting, helpful, and thought-provoking comments on the articles. I hope some will find our story inspiring! I always find real-life examples helpful, and so I have tried to be as open and transparent as possible.

There are so many moving parts to consider when deciding upon your strategy. I would say make a start as soon as possible – even if you are unsure or scared. Taking action is important. You can spend too much time researching, putting a plan together, and worrying about the right decision. If you are not actually taking any action, you are holding yourself back from progressing and the future you want.

You can evolve your strategy. You do not need everything to be perfect from the first step.

Learning: from the US to the UK

When did you first start thinking seriously about your finances?

In my early 20s after starting my first job. My father encouraged me to save and invest. He introduced me to ISAs and explained how they worked.

Did any particular individuals inspire you to become financially free?

My parents played an important role. I could see from their example that working hard, having a strategy, and trying to make the right decisions could provide you with future opportunities.

Can you recommend your favourite resources for anyone chasing the FIRE dream?

I split my time between US and UK websites, blogs, and podcasts.

Initially when I first discovered the FIRE community it was via the American websites and blogs. The first one I ever read was Millennial Revolution. I saw Kristy and Bryce being interviewed on a television program. A podcast I found interesting and helpful was Choose FI with hosts Jonathan and Brad. I also spent a lot of time reading the stock series on the J L Collins blog.

I then progressed onto the British blogs. They were directly relatable to my circumstances.

Monevator is a great source of information. I especially like the comments as you can learn so much from the different opinions and debates. I also enjoy Banker on Fire and Alan Donegan.

What is your attitude towards charity and inheritance?

We make donations to our local school and donate unwanted clothes, toys, and household items to charity shops. At some stage I would like to volunteer at a local organisation. Maybe give some of my time to people who are lonely, or who don’t see their family.

Regarding inheritance, we plan to leave everything that’s left to our children.

What will your finances ideally look like towards the end of your life?

Depending on market returns and our spending, we hope to have enough to see out our lives on our terms. We will leave our investments as they are for now. We hope there will be enough in the pot for it to keep growing in the long-term. We’re both due to receive state pensions, though not for the full amounts. They have not been included in our FIRE planning, so may add a little extra buffer.

Finally, we want to create many happy family memories and have a life well-lived.

Nice, eh? FIRE by your mid-40s, mostly on one (sizeable, but not sky-high) salary – and with kids! Clearly moving helped mightily, but saving and investing for 20-odd years was crucial. Questions and reflections welcome. Please remember Jake is just a reader and a one-time poster sharing his story to inspire others. Constructive feedback is fine, personal attacks will be purged. Thank you!

There’s a skeleton lurking in the UK’s financial closet. It’s the ghostly remains of a terrible bear market – one that makes Japan’s 31-year stock stagnation look like a temporary blip. This multi-decade decline was the UK’s ugliest bond market crash (and we’ve had a few).

It took 40 years to reach rock bottom. Losses peaked at -79% in 1974. Full recovery took until 1997 – over two decades later.

The whole horror show lasted more than 62 years and unfolded like this:

Data from JST Macrohistory1. February 2023.

Note: This chart – and this entire article – uses real returns2 that incorporate reinvested income.

The two sides of the graph form a jagged hell mouth that swallowed bond investors in the 1930s.

The magnitude and duration of the drop should dispel forever any notion that bonds are inherently ‘safe’.

Bonds are risk assets. It’s the often-divergent nature of their risk – as opposed to any supposedly invincibility – that can make them a useful complement to equities.

Well… sometimes.

The great bond market crash of 1935-97

A log view of the same chart shows how each downward leg of the bond market crash compares:

The -46% ledge-drop of 1972-74 alone was deeper than many stock market implosions.

But we must go further back – to the aftermath of World War One – to find the dark roots of this nightmare.

The trauma of that war gave way to mass unemployment as the Government cut spending and raised interest rates. Its priority was to recover Britain’s preeminence in international trade, and it was prepared to sacrifice the living standards of the general population to achieve that goal.

As wages and demand fell, Britain was wracked by deflation during the 1920s and early 1930s.

Deflation is like steroids for bonds – real yields rose, propelling gilts to a 480% return from 1921 to 1934.

But the Great Depression and unemployment as high as 22% put paid to the Treasury’s tough medicine – the market pushed Britain off the Gold Standard as the Bank of England’s reserves drained.

Yet ironically, the forced policy-reversal proved a blessing (and not for the last time).

The abandonment of the Gold Standard devalued the pound and gifted the Chancellor the freedom to cut interest rates. The resultant cheap money stimulated the economy3 but it also sparked inflation back to life.

And inflation is the arch-nemesis of bonds.

Inflation nation

Our next graph shows how surging inflation triggered gilt losses, while decelerating inflation eventually precipitated the bond market’s recovery:

The sharp spikes in the green annual inflation line correlate with a collapse in bond values. A recovery only began in the 1980s when the general trend pointed down.

If this were a game of Cluedo then it’s case closed. It was RPI inflation that did it, clobbering bonds over the head with the ‘basket of goods’ on the trading room floor.

The 60% loss incurred by 1956 is directly connected to the accelerating inflation that erupts on the chart from the late 1940s. That inflation reached double digits in 1952.

When Prime Minister Harold Macmillan said, “You’ve never had it so good,” he clearly wasn’t addressing bond investors.

The 1960s did provide some relief. Both inflation expectations and gilts drifted sideways.

But then inflation exploded. It jumped over 9% in ’73, 16% in ’74, and peaked at more than 24% in ’75.

1974’s -27% loss inflicted the third largest annual bond defeat of all-time (after 1916 and 2022).

The UK’s worst stock market crash reached its nadir that same year – but by New Year’s Eve the worst was over, despite inflation remaining in double figures for the rest of the 1970s.

A key takeaway from the chart is that nominal bonds aren’t crushed by high inflation per se.

Gilts made an annual gain of 11% in 1975 even though inflation was 24%, for instance.

Why? Because inflation wasn’t as high as the market had feared, and bond yields had already risen to compensate.

Do you yield?

The following long-term yield chart for the bond market crash period proves that investors aren’t defenceless in the face of inflation:

The graph tells us three things:

• As bond prices fall yields rise. It’s the law. (It’s also maths).
• Investors’ demand higher yields to protect their returns against galloping inflation.
• The stage is set for outsized bond returns if yields outpace future inflationary risks – and especially if interest rates trend down after you’ve locked in a good yield.

Back in 1935 the long-term yield was 2.9%. As yields spiralled they inflicted capital losses that – coupled with soaring inflation – explain the damage sustained by long-term legacy gilt holders:

Year	Yield	Cumulative loss
1951	3.8%	50%
1956	4.7%	60%
1974	15.2%	79%

Fast-rising gilt yields – accompanying inflation breaking loose in 2022 – similarly administered a -30% bond shock last year. 

Peak yield

Back in 1975, the yield had already dropped down to 14.6% as inflation crested. That crumb of comfort meant a small 11% bump in bond prices that year – just about visible as the beginning of the recovery in the gilts vs inflation chart above.

Inflation can remain blisteringly high when we think of it as consumers. But it is high and unexpected inflation that pains us as bondholders.

Inflation and yields trended down through the 1980s and 1990s, and at last those 1934 bondholders saw a positive return for the first time. Or perhaps their grandkids did.

As unseen Movietone News commentary of the era put it with characteristic plumminess:

Yes, it’s 1997! New Labour sweeps to power ending 18 years of Tory rule, and Aqua’s Barbie Girl is top of the Hit Parade!

Meanwhile, the class of ’34 are going bond bonkers! They’ve earned 3.4% in 63 years, or a whopping 0.05% annualised. The lucky blighters!

Movietone was not known for the depth of its financial analysis.

Survivor’s gilt

As benighted as the path was for investors caught in the jaws of that great bond bear market, anyone brave enough to bet on a comeback in the 1970s was set to earn equity-like returns.

Buying into 1975 gilts delivered annualised returns of 5.7% over the 10 years, and 6.5% over 20 years.

1982 rolling gilt returns were 9.3% annualised for the next decade – and 8.5% over two decades.

Which, incidentally, is a clue as to why it’s so tricky to call the bond market now.

If inflation subsides, you could be locking in a good yield that’ll deliver decent returns in the future – including substantial capital gains if interest rates fall.

But if inflation continues to go rogue then our nominal bonds will be as useful as a woolly bath.

What to do? We’ve previously explained why every asset class has a place in a diversified portfolio.

It’s best to spread your bets when reckoning with uncertainty.

Take it steady,

The Accumulator

Postscripts

P.S. It’s worth reiterating: this article uses inflation-adjusted total returns to understand exactly what investors’ earned during the bond market crash. Bond articles that don’t deal in real returns do their readers a disservice. For example, the 1935 bond bear market covered above is fully recovered by 1941 when judged in nominal terms.

P.P.S. The second most hideous UK bond market crash began in 1898 and hit -71% in 1920. Those investor’s were made whole by 1932, thanks to that deflationary bond bull market that followed World War One.

P.P.P.S. There’s one grim path that sees 1879 bondholders still underwater 102 years later in 1991. Their returns are perfectly respectable until World War One ruins them. They claw their way back into the black during the deflationary era, but the 1974 FUBAR leaves them staring at a loss again. Finally the 80’s bond boom pushes them back into positive territory where they remain today.

P.P.P.P.S. For a grounding in the mechanics of bonds, please read our pieces on rising bond yields and bond duration. We also have a handy jargon-buster that clarifies some bond terms that are useful to know.

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. [↩]
2. Real returns subtract inflation from your investment results. In other words, they’re a more accurate portrayal of your capital growth in relation to purchasing power than standard nominal returns. [↩]
3. Triggering a housing boom which left us the legacy of countless streets of 1930s semi-detached properties that still make wonderful homes today. [↩]