What caught my eye this week.

Now and then an investing writer will take aim at a staple of the genre – all those articles proclaiming the ‘miracle’ of compound interest, which detail how Precocious Pete who starts saving at 20 will trounce Tardy Tarquin who doesn’t get going until 40.

Nonsense, the doubters say. Pete hasn’t got a bean to spare, and Tarquin is rolling in it. Compound interest won’t do much for either of them (apparently). Instead it’s all about savings.

It’s basically shock jock blogging. Slaying the sacred cow to the awed gasps of onlookers.

And too bad if those onlookers get splattered in blood.

Okay, so there’s some truth in what these iconoclastic articles – which at best champion saving over investing, and at worst throw in the towel – say.

If you have £1,000 and you compound it by 10%, you still only have £1,100. Nobody is retiring on that.

In contrast nearly all 20-year olds reading Monevator can find £100 down the back of the sofa.

Ergo, like a complication-free hookup, compound interest is a myth that will do little for you until you’re too old to be bothered with it.

So forget about it! Save more when you (hopefully) earn a lot more in your 50s. Go to the beach instead.

I paraphrase but that’s the gist.

Them versus us

I’ve noticed these articles tend to be written by three kinds of people:

• Young people with little yet in the way of assets who wonder where’s their snowball?
• Older people who stumble into income or assets in later life, which transforms their finances.
• (Usually much) older people who never saved enough to retire early, and seem cross about it.

Notably not on the list are people who did start saving in their 20s. Who saw their snowball. And who now tell you compound interest can do a lot of heavy lifting.

People like me!

I was a regular saver from my teens. I’ve never earned six-figures, and most years didn’t trouble the higher-tax bracket (albeit later thanks to pension contributions). I mostly lived in London, which is expensive.

On the other hand I didn’t have kids, a car, or a drug habit.

And by the time I hit my 40s, my portfolio’s average annual return – the compound interest bit – was more or less equal to my earnings, net of tax.

Undoubtedly I made sacrifices to get there. Maybe I was too frugal. There are reasons why what seemed to me a generously-provisioned life would cause others to chafe. I’m a good enough (active) investor, which also helped.

But none of that disproves the impact of compound interest.

Roll the calendar another ten years and even despite a horrible 2022 – for my portfolio, my earnings, and my mortgage rate – I’m still (touch wood) set fair.

Savings played a big part in this journey. But I’ve never earned enough to be set without compound interest helping out too.

For sure I’m glad the books I stumbled upon in my 20s hit me over the head with a graph that went up and to the right, thanks to compound interest.

Rather than one that told me not to bother – not until I’d climbed over enough rats to get high enough up the greasy pole to stick at it and save in my 50s, 60s, and who knows maybe into my 70s.

Saving versus interest versus time

In my view savings and investing – and fitting your budget to suit your goals – are all important.

Doh, you say. (Unless you’re drafting your anti-compound interest post as we speak?)

Elsewhere ever-reliable Nick Maggiulli tackled this savings/investing duality in a novel way this week, with what he calls the ‘Wealth Savings Rate’.

It’s a way of seeing how your pot will grow (double) through adding new money via savings, as well as through compound interest.

Early on your Wealth Savings Rate is high. New money moves the dial materially.

But later, a whole year of extra savings might amount to one or two percent of your portfolio’s value. It’s the compounding that’s motoring you forward. By then you can run the numbers on leaving work if you want to.

Nick shows how long it will take to double your money under different saving and return scenarios:

It’s a cool lens he’s come up with, and one I can’t remember looking through this clearly before. Check out the full post on Nick’s blog, Of Dollars and Data.

And do keep saving and investing if you want to be financially independent sooner rather than later!

Have a great weekend.

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Serious capital losses can reduce our appetite for risk, just as surely as a night clutching the toilet bowl will put you off eating raw oysters for life.

But our psychological hard wiring presents us with a dilemma.

Foul, nausea-inducing returns now and then come with the territory in financial markets.

And we know these gut-wrenching episodes are liable to impact our future decision-making, because they trigger our impulse to avoid similar unpleasantness in the future.

In other words we’re prone to negativity bias. 

But common wisdom among many investing masochists veterans is that outsized profits are made after a market meltdown.

“Buy when there’s blood on the streets!” and all that charming imagery.

And if that’s true then our natural response to shy away from whatever just hurt us could do us more harm than good.  

UK equities: ten worst annual returns 1871-2022

So which view is correct?

Do awful returns fire the starting gun for massive bargains? Do you just need the testicular fortitude to scoop them up?

Or do market swan dives just as often signal that there’s more pain ahead, as feared by our savannah-ready emotional engineering?

The table below – which features real1 returns – shows how UK equities bounce back – or belly-flop – after their ten most negative single years since 1871.

Bad year	Return (%)	+1 year (%)	+3 years (%)	+5 years (%)	+10 years (%)	10yr annualised (%)
1916	-17.4	-12.5	-13.8	-36.2	50.1	4.1
1920	-31.8	8.6	71.1	137.7	181.2	10.9
1931	-16.5	37.8	99.7	167.6	78.5	6
1937	-15.9	-11.2	-28.4	-12.3	11.1	1.1
1940	-18.6	10.8	31.5	49.2	35.9	3.1
1969	-16.2	-9.4	31.8	-62.7	-12.1	-1.3
1973	-34.2	-57	-22.5	1.2	75.9	5.8
1974	-57	103.4	132.6	135.4	415.7	17.8
2002	-23.2	18.6	57	83.5	74.9	5.8
2008	-32.2	26.2	29	65.3	87.2	6.5

Real2 total returns from JST Macrohistory3. February 2023. 

One thing jumps out from this table – the severity of the first year’s losses tells us little about what’s coming next.

The very worst year (1974) led directly to the best year in UK stock market history – the 103% doozy of 1975.

Yet the second-worst year (1973) bled straight into the 1974 nightmare. (Indeed the two years fused into the UK’s worst stock market crash since the South Sea Bubble.)

Meanwhile, the third, fourth, and fifth bleakest years in our chart (2008, 1920, and 2002) were all followed by large rallies.

On the other hand, three of the five least worst-drops kept tunnelling down in year two.

More often than not, equities bounce back fast

On balance the table provides tentative evidence supporting the theory that a severe shock for shares can abate quite quickly.

This is conjecture, but perhaps in the best cases the bolder investors quickly see the panic has been overdone and pile in. Their forays restore confidence among the rest of the herd, leading to further gains.

Milder hits may not flush quite enough negativity out of the system within just a year, however. Hence there’s a fairly strong chance that escalating disquiet blows up into a deeper decline in year two.

Or maybe it’s all to do with the credit cycle or a dozen other theories…

The recovery position

Whatever the driver, a recovery is usually under way three years after the initial slump.

Seven out of ten aftermaths feature high single- to double-digit average growth. By the third-year mark, the ranges4 rove from 9% annualised (after the Financial Crisis) to 32% annualised (post-1974).

Those return rates are chunky compared to the historical average return of around 5% for equities.

Less happily: we can see three events were in contrast still poisoning the water supply five years out. And one was still pishing in the pond after a decade.

Two of these periods were hamstrung by the World Wars. The other (1969) slid into the 1972-74 crash and the worst outbreak of inflation in UK history.

Yet even these observations don’t enable us to formulate a simple heuristic such as: ‘bail out for the duration of a major war or stagflationary malaise’.

For one, the ten-year returns beyond 1916 are perfectly acceptable, if nothing to brag about.

Next, let’s examine the difference in an investor’s fate after 1973 compared to 1974.

What a difference a year makes

The post-1973 path took a decade to straighten itself out. In contrast, you were skipping along like it’s the Yellow Brick Road straight after 1974.

But realistically, how many investors who’d just been through the 1973 shoeing would be itching to double-down after the -72% roasting inflicted by the end of 1974?

You’d have to be a robot – or rich enough not to really care about losing money – to wade in after that two-year bloodbath.

Still, if you held your nerve you were handsomely rewarded. Returns were close to an extraordinary 18% annualised for the next decade.

The really unlucky cohort were the 1969-ers. These guys suffered a relatively mild recession at the tail-end of the ’60s, but they then ran smack into the 1972-74 W.O.A.T.5, and ended up with negative returns after ten years.

Ultimately, these investors recovered to 5% annualised respectability.

But it took 16 years of keeping the faith to get there.

World equities: ten worst annual returns 1970-2021

How does the picture change if we look beyond UK equities? We have good data on the MSCI World index going back to 1970.

Let’s see how quickly (or not) global equities bounce back from the abyss:

Year	Return (%)	+1 year (%)	+3 years (%)	+5 years (%)	+10 years (%)	10yr annualised (%)
1970	-10.2	2.1	-2.2	-25.3	-37.9	-4.6
1973	-22.6	-38.1	-10.5	-27.8	7.2	0.7
1974	-38.1	23.4	16.1	0.8	116.8	8
1977	-19.7	0.6	-11.5	15.8	136.2	9
1979	-13.7	1.9	33.4	115.1	311.1	15.2
1987	-11.8	22	-2.6	26.5	112.5	7.8
1990	-35.5	14	59.1	83	213	12.1
2001	-15.6	-28.7	-11.3	8.8	4	0.4
2002	-28.7	18.1	49.4	60.4	57.4	4.6
2008	-20.3	12.4	14.1	50	126.8	8.5

Real total returns (GBP) from MSCI. February 2023. 

Quick aside: last year’s -16.6% loss slots in at no.7 on the World Annus Horribilis chart. But I’ve excluded that result because, well, we don’t know how it turns out yet.

The pattern of the worst routs leading to the best rebounds mostly holds true on the world stage, too. 1973 proves to be the exception once more.

We can also see the past 50 years has been much kinder to stocks than the first half of the 20th Century. There were no World Wars, Great Depressions, or what have you.

Nevertheless it still takes five years before a majority of the sample periods turn positive.

At the three-year mark, half the pathways are underwater.

But five years on, and only two scenarios are negative. Of the goodies, two are positive but miserable, two have average returns, and four above-average to superb.

Finally, at the ten-year mark, three of the timelines were all told a thankless slog. (Think working in the laundromat in Everything Everwhere All At Once.)

The others are all excellent though. Well, except for post-2002. It hovers right around average.

UK gilts: 10 worst annual returns 1871-2021

Now let’s consider UK government bonds.

Year	Return (%)	+1 year (%)	+3 years (%)	+5 years (%)	+10 years (%)	10yr annualised (%)
1916	-32.5	-17.7	-36.7	-35.2	8.6	0.8
1917	-17.7	-7.5	-38.3	6.1	44.8	3.8
1919	-16.8	-19.7	38	65.4	98.7	7.1
1920	-19.7	27.4	90.5	106	188.1	11.2
1947	-19.9	-6.5	-17.1	-38.3	-50	-6.7
1951	-17.2	-10.2	2.3	-19.3	-31.7	-3.7
1955	-14.5	-7.7	-5.3	-12.4	-10.1	-1.1
1973	-16.6	-27.2	-20.5	-8.7	26.8	2.4
1974	-27.2	10.9	38.3	17.3	73.3	5.7
1994	-12.2	14.5	38.2	56	99.3	7.1

Real total returns from JST Macrohistory. February 2023. 

Quick aside part two. Last year’s -30.2% ranks at number two in the UK gilt all-time losses chart. But again 2022 is excluded due to crystal ball malfunction.

First thing to notice is that the UK’s worst one-year bond losses aren’t much more gentle than our grimmest stock market losses. (And they’d be nastier still if we threw 2022 into the mix.)

Partially that’s because the UK’s historical gilt benchmark was stuffed full of highly-volatile long bonds. Bond drops are gentler if you stick to shorter durations.

But much of the story hinges on inflation. In fact the only three positive years in the ‘+1 year’ column occurred because heightened inflation fears subsided, rather than escalated.

Roll the time-tape on three years, and the only middle-ground is the post-1951 nothing burger.

Every other path is either a double-digit return spectacular, or else it’s negative growth purgatory.

But it’s the five-year column that really shows how a bond bounce-back can be arduous.

Fully 50% of this sample still remains in the red at that point. Whereas we’d seen 70% of UK equities bounce back by the five-year post-crash mark.

What was that about slow and steady?

Remember, over the long-term we’re not expecting much more than 1% annualised real returns from government bonds.

Yet by the time a decade has elapsed, only one outcome from our sample of worst starting points has delivered anything like that.

Four of the following decennial returns are equity-hot. (That’s good!) Two are great, at least for bonds. But three would leave you ruing the day.

That latter trio of roads to nowhere (1947, 1951, 1955) were all caught in the middle of the UK’s biggest bond crash. Inflation kept slipping its leash and mauling the real returns from fixed income.

Hope for the best, but be ready for the worst

While none of this data is predictive of future outcomes, I think we can draw a few general lessons.

Firstly, the worst equity crashes are not predictive of more slaughter to come. The majority are a reset that auger better days ahead. Equities bounce back and usually sooner rather than later.

If you’ve just taken a heavy hit in the stock market then your best (but far from guaranteed) route back to profit is to hang in there. The market should fairly quickly pick up speed again.

Eventually any market will almost certainly right itself. That’s why equities and bonds have positive return records going back 150 years and more.

But the rebound may not happen according to a timetable that suits you. The longest string of successive negative returns for UK equities was 12 years straight.

Incidentally there’s also an outlier pathway in the historical record that does nicely for 18 years, and then collides with World War One. That calamity saddled 1897 equity investors with a negative return after 25 years!

An extreme event for sure. But it helps illustrate why 100% equities is a risk. The expected returns you’d planned for may not be there when you want them.

Do you have bouncebackability?

Most of us are likely to go through the investing meat grinder at some stage in our lifetimes. That’s the price of entry as an investor.

Just think of all the big crashes recently. How many investing experts managed to swerve the Global Financial Crisis? The Covid crash? Or the inflationary shock of 2022?

Predictive power is in short supply. Rather it’s staying power that we need.

We say keep your head together after a bad run and don’t chase the market. Give it time and it should turn in your favour. Sooner or later your patience will very likely be rewarded.

Take it steady,

The Accumulator

P.S. This concept was inspired / shamelessly cribbed from US asset manager and author Ben Carlson. See his post on US stock and bond rebounds. But I’d just like to say in my defence that I’m a big fan of Ben’s work. And I’d do it again, so help me!

1. That is, inflation-adjusted. [↩]
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. 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. [↩]
4. Three-year annualised return, not shown in the table. [↩]
5. Worst of All-Time! [↩]

What caught my eye this week.

Three years ago this weekend I began to write on Monevator about the new coronavirus, which by late February had gotten the attention of the markets:

Things were definitely feeling freaky by the fourth day of 3-4% declines.

When the US market bounced higher into the close on Friday – perhaps on the expectation that central banks will make some sort of statement about interest rate cuts this weekend – you could almost feel the relief, even though all the main indices still ended the day in the red.

UK government bonds, for the record, are up.

Unstoppable

Just in case you’ve been living in a bunker – which is where we’ll all be in a few weeks, according to some – the cause is the novel coronavirus.

COVID-19, as we groupies have started to call it.

Together with a few geeky friends I’d monitored Covid’s spread via then-obscure health sites and academic services since Christmas. I already had my mother self-isolating. And during a rare meeting with The Accumulator on the first Sunday of February, I’d shocked him by revealing I’d sold a huge portion of my portfolio and was even holding gold.

That all sounds very smart and prescient. But the fuller story is far more muddled.

For starters I’d bought back a lot of my equities just two to three weeks later!

The market wasn’t crashing, you see, and it’s usually right. I started thinking that maybe @TA was correct that this virus could prove to be just another localized SARS-type outbreak.

Notes from Underground

Unlike many people, I’ve a written record here on the blog – especially in the comments – of my thoughts over the weeks and months that followed.

This reminds me what I believed as our understanding of the virus evolved. As opposed to what I wish I did!

It’s a good check on hindsight bias and selective memory.

Some things I was ahead on, such as the long-term disruption caused by repeated lockdowns. I’d argue the way things played out also vindicated an early belief that we should overwhelmingly concentrate on protecting the oldest people. I was right too to get optimistic about shares again as soon as late March, when the fiscal spigots opened. And I correctly favoured technology firms.

But other stuff I got very wrong.

In retrospect I couldn’t get my head around the virus being a dial-shifting issue for years. I kept looking for signs of a speedy resolution – maybe as soon as the end of 2020. My efforts at being an amateur epidemiologist did afford me moments of insight.

But overall I would have done better just to listen to the pros. Although many of them were, like me, too optimistic about the ability of vaccination to halt transmission.

The Plague

Anyway all these debates played out in the comments on this website – and that itself was interesting too.

In the early days we had a free and open debate. Regular commentators took varied views, but I’d say there was mostly an understanding that there were open questions and we were all feeling our way in the face of something personally unprecedented.

But after just a few months some sort of crystalizing took place. Positions hardened. Politics entered the picture in a big way. And like most things in our benighted political times, what began as a health issue became a binary them-and-us stand-off.

At the least I shuffled across one side of that line too.

Being and Nothingness

My aim in recalling all this is definitely not to do any sort of finally reckoning as to who was right about what – let alone who ‘won’ the pandemic.

Too many are doing that now, especially in the US.

The worst of them are almost willfully dismissing or forgetting just how uncertain and afraid we collectively were in those early months of 2020, as we watched hospitals overflowing with the dying from the enforced confines of our own homes.

And it’s rather that which I want to recall.

Trivially, the time has come to remove my ‘Covid Corner’ as a regular section in the Weekend Reading links.

The virus is endemic. And though some would say the pandemic isn’t over, 60 seconds on any High Street shows that nearly everyone who can do so has moved on.

But it’s more what that crisis confronted us with that I want to put a pin in today – before we trundle into the next furore.

Because it’s rare to see your world turned upside down in a matter of weeks as happened in March 2020.

Even if you’ve come to see the lockdowns as a sort of pleasant holiday from reality, say, the fact is that for a period the authorities compelled you and most people you know to stay at home, while at the same time going out could conceivably get you killed.

Normally a country needs to go to war for such existential disruption. Sadly Ukrainians have had a double-dose of it in the past year, but if we’re lucky many of the older among us may never face such a period again.

I think it’s worth some intentional archiving.

Waiting for Godot

For myself, I want to store away the feeling of uncertainty. The spectrum of fear. The collapse into tribalism. The strangeness of shopping and swerving among the other masked figures. The oscillating emotions towards those who broke the rules. The groping for answers.

The specter that seemed to stalk us.

The debates about this or that policy will continue for a while. But in time they will become accepted truisms, depending on how you lean. Like the Thatcher government’s response to the Miners’ Strikes or US involvement in Vietnam.

The nuance will be forgotten. Yet even now scientists can’t convincingly decide if masks made a meaningful difference to transmission, for example.

It’s nuance all the way down.

I’ll end with some great lines from Yeats. I’ve always liked the sound of them. But the past seven or eight years have also shown me the truth of them:

Turning and turning in the widening gyre   

The falcon cannot hear the falconer;

Things fall apart; the centre cannot hold;

Mere anarchy is loosed upon the world,

The blood-dimmed tide is loosed, and everywhere   

The ceremony of innocence is drowned;

The best lack all conviction, while the worst   

Are full of passionate intensity.

Never waste a good crisis, say the politicians. They mean the chance to bury bad news or to take tough decisions.

But I’d hope a crisis might also teach us to be a little wiser too.

Have a great weekend – and let’s enjoy our freedom to do so.

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