With the UK sliding into recession, war ruining Ukraine, and inflation stalking the High Street, now may not seem like a good time to invest.

Perhaps it’d be best to keep your financial powder dry? To wait for better days?

That makes perfect, intuitive sense – until you step back and look at the bigger picture.  

In the long run, equities go up

The bigger picture looks something like this: the most reassuring chart in investing…

Data from JST Macrohistory 1. November 2022.

The chart shows inflation-adjusted, UK stock market total returns2 surging through 150 years of upheaval and periodic catastrophe. 

Despite the regular, tragic punctuation of financial and human carnage, equities kept rising over the long-term. 

And whatever challenges we’re facing now, they’re unlikely to be as disastrous as the devastation wrought by the one-two punch of World War One and the Spanish Flu.

Or the Great Depression followed by World War Two. 

The UK’s worst stock market crash was the -73% real terms decline that played out over 32 months of misery from 1972 to 1974. 

You can see the gouge it tore in the graph above during the years of stagflation in the 1970s. 

But progress eventually resumed. Just as it did after the Dotcom Bust (-44%) and the Global Financial Crisis (-43%). 

Even the recent Covid crash barely registers in retrospect. 

Investing is one damn thing after another

Perhaps our current woes auger the next calamity? Maybe it would be best to batten down the hatches for now?

Time will tell. But the world is always troubled. 

Here’s a catalogue of threats that menaced investors in the years that followed the Global Financial Crisis: 

• 2010 – Greek bailout, The Flash Crash
• 2011 – EU debt crisis, double dip recession, US downgrade
• 2013 – The Taper Tantrum, US government shutdown
• 2015 – Chinese stock market crash
• 2016 – Brexit referendum, Trump election, Fed rate hike jitters
• 2018 – US-China trade war, quantitative tightening 
• 2019 – Inverted US yield curve, Great Stagnation warning
• 2020 – Covid, running out of Netflix shows in lockdown
• 2021 – Covid, Evergrande liquidity crisis, global energy crisis
• 2022 – Inflation surging, Russia invading Ukraine, deepening energy crisis, global downturn

Scares and setbacks continually close in on us like the walls of the Death Star’s trash compactor. 

In fact you could reach back into history and put together a list of cascading crises, dire prophecies, and apocalyptic warnings for almost any year. 

But there’s no point living like that.

On a personal level it would mean never stepping into a car, or dating, or going outside. 

Financially, it’d mean measuring your wealth in prepper stockpiles rather than in the stock market. 

To achieve anything like the (272,700%) growth of £1 shown on the chart, we must accept some risk and uncertainty. 

We can stay the course by keeping our eyes on the prize, not the temporary reversals.

Pain is why you are paid

Many of the market’s biggest opportunities have followed its most dramatic falls. 

Prices rocket when investors eventually realise they overreacted to the last shock. 

But human psychology guarantees you’ll fail to grasp those moments if you don’t upgrade your mental firmware from the basic fear and greed package. 

Greed sucks us into rising markets. Think 19th Century Gold Rush or 21st Century Crypto Bubble. We’re like moths to the money flame. 

Then we get burned. Fear takes over and instructs us to: “Freeze! Just chill for a while. Let’s wait and see what happens.” 

And then all of a sudden the market marches on without us. We miss most of the rally…

…until eventually greed overwhelms our fear again – dragging us back into the action because nobody wants to miss the last train to Fat Stacks City. 

This is the chimp version of scissors, paper, stone. Greed beats fear. Fear beats greed. We flip-flop in time to the market’s beat, but out of tune with the opportunity.

Playing the market this way only increases the risk of buying high and selling low. 

But wading in when your instincts scream: “Danger! Danger!” will increase your odds of buying low and selling high. 

As Warren Buffett puts it: “be fearful when others are greedy and greedy when others are fearful.”

Is now a good time to invest?

Now is as good a time as any to invest because for the vast majority of people it’s time in the market that counts, not timing the market. 

In retrospect, the historic traumas charted above proved brief downward squiggles on the great graph of historical returns.  

Progress is not inevitable, of course. But we shouldn’t lament the lack of guarantees either.

Uncertainty is the gunpowder that propels our future returns. It’s exactly because of the risk of loss that investors demand the prospect of higher returns from equities. 

No-one gets paid for betting on a sure thing. But buying a stake in the continued progress of humanity – and its main engines of productivity – has paid off for the past 300 years.

If you believe the arc of progress bends towards the good then owning a diversified portfolio of equities is a wise investment, alongside other useful asset classes.

Check out our guide on passive investing to see how to make it work. 

Take it steady,

The Accumulator

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. We’re using UK stock market returns but the picture would be similar if you used the US or the World market. [↩]

What caught my eye this week.

Now it seems like we were dreaming. The huge tax cuts. The dash for growth. The chancellor telling Laura there was more to come.

That strange Push-Me-Pull-You Mini Budget that blew up the gilt market, threatened pensions and banks, and sank yet another Tory prime minister.

Was it really only two months ago? Have we all done a Bobby Ewing?

Because if you happened to emerge from an all-consuming illness on a hospital ward this week to tune into the latest chancellor’s Autumn Statement, there wasn’t a whiff of any of it now.

Instead of tax cuts, the UK faces the highest tax burden (at just over 37% of GDP) since World War 2.

And about the only thing forecast to grow is the length of a recession that’s already underway.

Tax and don’t spend

Anyone who is interested will have heard the main points from Jeremy Hunt’s Statement by now.

More people paying the highest-rate taxes on more of their money. Frozen income tax thresholds that will mean all of us will pay a higher share of our income as tax, even as our wages are inflated by inflation. An axe taken to capital gains and dividend tax allowances. The pension triple-lock held.

Just in case you did sleep through it though, the main points from a personal finance perspective:

• The Autumn Statement: item by item – This Is Money
• Autumn Statement: What it means for your money [Search result] – FT
• How the Autumn Statement will affect various households – Guardian
• What you need to know about the Autumn Statement [Podcast] – Which

There was also the usual hodgepodge of measures to do with business, regulation, and investment. They amount to fiddling at the edges.

The result makes grim reading. Real incomes per person are forecast to fall 7% over the next two years – the biggest decline on record.

And then just when we’re dusting ourselves down, Hunt’s planned spending cuts will start to starve State spending.

Those cuts don’t kick in until 2024, either to give the Conservatives a chance in the General Election that year, or else because if they were front-loaded along with the tax cuts – and in the midst of a recession – then the economy might really fall off a cliff.

Probably a bit of both.

More pain, no gain

The only good news is the market is calm. Gilt yields have come down since Hunt took the reigns, and fixed-rate mortgage rates are following.

And I can entirely understand the logic of this Autumn Statement, especially in the light of what we went through under Liz Truss and Kwasi Kwarteng.

They showed the UK cannot afford to be reckless when it comes to market confidence. We’ve borrowed far too much for that, with our economy too dependent on the kindness of strangers.

Yet as I pointed out at the time, Truss and Kwarteng also correctly identified the UK economy is going nowhere as things stand, with stagnant real wages, no productivity gains, and barely-there economic growth.

Even with Hunt’s fiscal retrenchment – worth about £50bn, or about 2% of GDP – the Government’s payments on debt interest are still forecast to be £100bn a year by the end of the forecast period.

That’s more than we spend on any single public service except the NHS, says the IFS.

It adds that by the end of the period we’ll still be borrowing about £69bn a year.

Remember, that is additional debt, on top of a tally already sat at c. £2,500 billion.

If this is Austerity 2.0 then it’s worse than the original. At least George Osborne told us his cuts would be worth it to move the UK back into balance.

It all adds up

Indeed it’s hard to find any reasons for optimism about Britain for the next few years. Hunt is like a 19th Century doctor who promises he can save your life, then reveals the bone saw he’s going to use to cut off your leg.

Yet does he have any choice?

If the energy crisis hadn’t blown up and inflation hadn’t skyrocketed then things wouldn’t be so bleak. Obviously the vast spending during Covid to pay people to stay at home didn’t help either.

And if Truss and Kwarteng hadn’t frightened the horses then we wouldn’t now need to be trying to gee them back through flapping stable doors.

Oh, and there’s obviously the small matter of Brexit permanently impairing our economy. That hit is likely worth about £40bn a year to state funding – around the size of the hole Hunt is aiming to fill.

At least we voted for that one.

Things can only get better worse

Some readers hate gloomy posts. You come to an investing blog to be inspired, not dispirited. I can understand that.

But the best I can suggest is you continue to read us and pay even more attention to your finances. If anything, it’s more crucial than ever. Look after the pennies, and invest for the future because on the face of it the economy isn’t going to make it easy for you.

The only inspirational call here must be to control what you can, not be knocked off-course by what you can’t.

Who knows? Maybe Putin will look at his kids one morning and decide to pull out of Ukraine. That would be helpful.

But as things stand, there’s no getting around it. Britain is an impaired asset. It is run by old managers who triple-lock their incomes and shout at the telly while sat in properties inflated by vast windfall gains and collectively voting to make things worse for their grandchildren.

The country thinks it is richer than it is, confused by the reality of a successful top-tier (which includes the average Monevator reader, to be clear) and ancient visions of Empire.

In 2016 it decided to make things even worse on the back of a hissy fit. There was no upside.

And I’m truly sorry, but now we have to suck it up.

Enjoy the weekend regardless.

[continue reading…]

Across the Monevator comments and beyond, a cry has gone up: “Bonds are bad! Down with fixed income! Duration is for dummies! Stick your equity cushion where the sun don’t shine!”

It’s not hard to see where the hate comes from.

2022 has been a terrible year for bonds.

I don’t mean terrible ‘for bonds’ in the sense that bad years for bonds are less common than for shares, meaning you’re disappointed with, say, a minus 5% annual return.

It has not been a bad year for bonds like Oswald Mosley wasn’t that bad for a Nazi.

No, it’s been a bad year in the sense that some bonds and bond funds – those of lengthier duration – have done even worse than the risky US Nasdaq index – which itself has had a rotten year:

Clued-up investors know equity declines come with the territory. Fair enough.

However we own bonds mostly because we hope they’ll do better than shares when that happens.

That’s why 2022 stings so much. It’s not just that bonds have fallen a lot. It’s that they’ve fallen when shares are down too.

Bad for bonds is worse for LifeStrategy

Because long duration bonds have done so much worse than shares – especially US shares, juiced by currency gains for UK investors – we see surprising and ghastly results like this:

Source: Trustnet

The chart shows how Vanguard’s popular LifeStrategy funds have put in a Bizarro World performance this year.

• The supposedly lowest-risk LifeStrategy option – the 20/80 fund, with just 20% in shares and 80% in bonds – has done the worst.

• The best LifeStrategy fund to own in 2022 was 100% in shares.

This is the opposite of what we’ve come to expect from balanced funds like LifeStrategy.

And let’s be honest – it sucks.

It’s one thing to lose money in the hurly-burly of the stock market.

High risk, high reward, right?

It somehow feels far worse when your pension is battered by boring old bonds.

The trouble is the same unwelcome double act has done for both bonds and shares this year – high inflation and rising interest rates – with lofty starting valuations for both asset classes having a supporting role.

Hence in 2022 bonds and shares have moved down together.

So are the newly-converted bond-o-phobics right? Have bonds been unmasked as wolves in sheep’s clothing? Ripping your face off just when you could really use some comfy woolens?

Should we junk our bonds faster than Tories getting rid of a Prime Minister?

Not so fast.

Not such a bolt from the blue

The potential for bad years for bonds was always in the small print – and the history books.

Moreover the risk of a bad spell for bonds only rose as prices climbed and yields fell.

Of course, we human beings tend to think the opposite way. The longer something bad doesn’t happen, the more we dismiss the risk.

(This is also why every outdoor activity with children eventually ends in tears…)

And after a 40-year bull market for bonds – longer than many City careers – complacency was at an all-time high.

But the risks were still there, if you wanted to see them.

Way back in 2012 I explained how bonds looked more vulnerable as Central Banks lowered rates:

What makes bonds particularly risky at the moment is the low yields you get for holding them.

As we’ve seen, this increases duration, and so makes them much more vulnerable to interest rate shocks.

I held no government bonds myself, preferring cash. As I wrote then, gilts “gave me the willies”.

This was my stance for a decade. Seems a good call now – but the fact is until this year it was a losing trade to prefer cash over bonds for safety.

In my 2012 piece I also said I couldn’t imagine yields on a ten-year bond would go much lower than the prevailing 2%.

But they eventually went to near-zero, boosting returns for bond owners.

Moderation in all things. Even bonds…

My co-blogger The Accumulator has also flagged the issue many times before this annus horribilis:

• Why UK inflation-linked bonds might not protect you from inflation
• Negative yields on bonds: what do they mean?
• What the warning signs about the 60/40 portfolio are telling us
• Defensive asset allocation and model portfolios
• How much will you lose if bond prices fall?

Like me in 2012, he also suggested holding more cash as one response to very low yields. But being the grown-up in the room, The Accumulator also urged readers not to dump bonds entirely.

Instead he stressed you could choose lower duration bonds to make your portfolio less vulnerable to an interest rate shock.

Why didn’t we bail on bonds?

What none of our articles did was declare in 72pt bold font:

SELL YOUR BONDS – NEXT YEAR WILL BE TERRIBLE.

Indeed you’ll wait a long time to read an article like that on Monevator.

That’s not because we keep such secrets to ourselves. Rather it’s because we have no idea exactly when crashes of any kind will happen.

For The Accumulator, knowing your limits is a key plank of the passive way.

For me, a naughty active investor, it’s a perspective hard-won from years of trying to second-guess the market.

But this is not a cue for you to read a different website – let alone turn to TikTok – instead of sticking with us.

Because I don’t believe anyone can tell you exactly when to get in and out of markets, consistently.

Sure, you will find thousands of people making comically precise market predictions all over the Internet. Some of these people are quite popular. But that doesn’t mean they’re any good at it.

Everyone has a hunch now and then. And after a drink, I’ll tell you I think I do better than average.

For example here’s a bottom. And here’s a top.

I think I do okay, by the standards of a scurrilous game. But the fact is it’s hard to distinguish skill from luck – or more importantly to bank on it.

I don’t urge you to avoid making wholesale moves in and out of different asset classes (as opposed to judicious tweaks or re-balancing) not because I don’t trade my portfolio. But because I do.

Mugged by the market

Since 2010, some commentators – including me, as we’ve seen above – were saying bonds were over-priced and bound to crash when yields rose.

But as it turned out, bonds delivered solid returns for many years to come. Culminating in a final flourish in the 2020 Covid crash.

How many people held themselves – or their preferred pundits – accountable for getting those predictions of a bond crash wrong, year after year?

Of course you might argue it didn’t matter exactly when the bond crash happened. It’s been so deep you could have bailed on bonds in 2015, say, and still dodged a lot of pain.

True – but that statement is neck-deep in hindsight bias.

Once you’d sold your bonds, you had to put the money somewhere.

Maybe into low-to-zero yield cash?

It’s taken a crash of 2022 proportions for that bet to come good. There was no certainty it would.

Equities?

Sure, if you chose US or global equities then these have beaten bonds over the past decade.

But (a) you were and are always likely to get a higher return from equities than bonds, and (b) the risk is you don’t. Equities are far more volatile than bonds.

In some parallel universe, we saw a huge equity crash in 2016 that we’re only now limping out of. For the past six years in that alternate reality, even low-yield bonds did better than shares.

Or maybe there’s a universe where we’re still looking for a Covid vaccine, and the world is mired in a 1930s-style depression.

I don’t want to think about what our portfolios would look like in that reality. But I’m confident that bonds would be doing better than shares.

Investing: probably, likely, could, might, may, should

The trouble is we’re not good – as humans – in thinking about probabilities as a basket.

Something with a one in 50 chance of happening will happen, given enough throws of the dice.

Whereas people try to mentally transform risk like this:

Relatively lower risk = lower risk = low risk = no risk

That’s totally wrong. Bonds being relatively lower risk than shares never meant there was no risk.

It’s better to think of a diversified portfolio as a basket of relatively higher and lower risks, where something is definitely going to happen. But you don’t know what will happen in advance.

So 2022 should not be teaching you that bonds are bad, just because they’ve had a terrible year.

That would be like avoiding shares after the Dotcom bust of 2000, or never buying your own home after the early 1990s property crash.

The better lesson we should take from 2022 is very bad things can happen to our portfolios.

And that if a lot of things can happen, then some of them will.

This year it was bonds that blew up. But plenty of other historically rare but perfectly possible things are waiting to derail us in the future.

And in some of those situations, high-quality government bonds will be your best friends – especially now they have a meaningful yield again.

When you’ll be glad you own bonds

Here are a few plausible scenarios where you’d probably be glad you kept some bonds:

Deflation – Strictly a regime of falling prices, deflation tends to be associated with higher unemployment, lower economic growth, stagnant or falling wages, and weak or negative stock market returns. But the best paper assets – government bonds and cash – can hold their value as the rest of your portfolio tanks. If yields fall then bonds can give you a capital gain to offset losses elsewhere. Whereas cash is likely to be yielding nothing.

A big and prolonged equity market crash – I’m not talking about a wobble like late 2018 or early 2020. Even 2022 hasn’t been particularly painful compared to the worst stock market crashes of all-time. Rather, imagine if your shares drop 70% and stay down for years. Bonds will probably do much better, at least in nominal terms. (However some very bad bear markets for shares coincided with big inflation-adjusted declines for bonds. You’ve been warned!)

A short sharp meltdown – Think the Global Financial Crisis or another deadly pandemic. This overlaps a bit with the previous entry. But the distinction is that a meltdown or confidence ‘flash crash’ is short-lived. Bonds may give you speedy gains upfront. You can then re-balance into rebuilding your battered equity exposure for the long-term.

You’ve retired – If you quit work to live off a 20/80 portfolio, pregnant with bonds, I excuse you a hollow laugh. 2022 has been awful. But over longer spans of time, bond returns are much less volatile than shares. When you’ve no new money coming into your portfolio and less time to sit out the declines, that’s valuable.

We’ve written extensively about the role of bonds, so I won’t repeat it all here:

• Are bonds a good investment?
• Should you hold cash instead of bonds?
• A brief guide to the point of bonds
• Best bond funds and bond ETFs

Read those and our other articles about bonds for a reminder about the merits of this asset class.

And try to do so without wearing your blood-tinted glasses of 2022.

Yes the long-awaited bond crash has finally happened. But we’re probably through the worst. If anything, it’s less likely to happen again anytime soon. At least not to the same awful extent.

One very bad year doesn’t entirely destroy the logic of owning some bonds, no more than the sinking of the Titanic killed the need for global travel.

Better days ahead for bonds

As we’ve explained before, falling bond prices have a silver lining. When bond prices fall, yields rise. And that bodes well for future returns.

As of early October, Vanguard’s models suggested that between 30 June 2021 and 30 June 2022:

… projected 10-year annualised returns for UK aggregate bonds have risen from 0.6%-1.6%  to 2.4%-3.4%, while return expectations for global bonds ex-UK (hedged) have increased from 0.5%-1.5% to 2.3%-3.3%.

Again, low returns had been baked-in. Now they look a lot better.

On a related note, the fund behemoth has also modeled how future expected returns from a 60/40 portfolio improved from the end of 2021 compared to late September 2022:

According to the latest forecasts from the Vanguard Capital Markets Model, the projected 10-year average annualised return for a 60/40 portfolio has increased considerably since the start of the year, from 3.3% to 6.8% – a rise of 350 basis points.

I will triple underline these are expected returns. They are not guarantees!

However the mathematics of fixed interest means that models can be more confident about future returns from bonds, compared to shares.

And those future returns look brighter.

If history is any guide it probably won’t be too long before even the battered 20/80 LifeStrategy fund is back in the black:

Again, you can’t be certain with a forecast. But at the least it shows you why I’m so wary of all the pessimism about bonds right now.

If anything, I’d be buying them. (In fact I am).

Bonds are not bad, but prices can be

I would be a hypocrite if I said you should always own bonds. I didn’t own them for a decade and perhaps in the future I’ll be out of them again.

But equally I’m not a supposedly passive investor now bailing on bonds after a very bad year.

If that’s you, then ask yourself:

• What do you know better than the multi-trillion dollar bond market?
• If the answer is ‘nothing’, then aren’t you just responding emotionally to recent losses?

This isn’t a call to excessively load up on long-duration bonds. Interest rates could go still higher. If they do then after a recent mini-recovery, bonds could decline once more.

There’s even an argument that bonds tend to move in long secular cycles. If that’s the case then we might be in for decades of rising yields and mediocre returns.

It’s also perfectly possible for bonds and equities to both keep doing badly for years – especially in real1 terms.

Again, no guarantees.

But let’s learn the right lessons from 2022. By all means diversify your lower-risk assets with cash and gold. Stick to intermediate or lower-duration bonds if you’re concerned about interest rate risk.

Or even be a naughty active investor like me. Own what you like, but be ready to sell on a whim!

(Just know you’ll probably do far worse for trying, and you’ll definitely be more stressed.)

But you should probably own some bonds

Frankly, if you’re someone who now thinks bonds are bad – full stop – then you’re probably the sort of person who most needs bonds in their portfolio.

Ideally tucked inside an all-in-one fund where you can’t see how the sausage is made. Because something is always doing badly in a well-diversified portfolio.

I don’t mean this unkindly. The opposite. I know it’s been a rotten year.

However I’m worried some people are going to load up on equities, only to sell out at the bottom when the next deep stock market crash comes and they have no safety cushion at all.

Shares are riskier than bonds. Not this year, but most years.

And there are pros and cons for every asset class.

You think bonds are bad? That’s a shame, because they haven’t looked this good for ages.

Never say never again

1. Inflation-adjusted. [↩]