Sometimes in investing you find yourself going nowhere. It’s both dull and unsettling at the same time – like being trapped in ice on a wooden sailing ship. Stuck fast, yet unavoidably alert to every crack and moan as a frozen fist constricts around the hull.
Boredom and impotence are formidable tormentors. How long will your passive investing faith ward off the urge to do something?
Perhaps it’s not quite that bad. But the fact is our Slow and Steady portfolio has barely moved for a year, in nominal terms. Which means it’s actually down about 8% after inflation.
After a jolt forward last quarter, the portfolio subsided another fraction these past three months.
Once again, it’s mostly our government bonds that have done the damage. Our UK gilts fund lost another 6.2% this quarter, and is down 7.1% annualised. Call that a 10% average loss, after inflation, for every year of the portfolio’s life. That’s hard to stomach.
Meanwhile, the overall annualised return of the portfolio is now 6.17%, or around 3% in real-terms:
The Slow & Steady portfolio is Monevator’s model passive investing portfolio. It was set up at the start of 2011 with £3,000. An extra £1,200 is invested every quarter into a diversified set of index funds, tilted towards equities. You can read the origin story and find all the previous passive portfolio posts tucked away in the Monevator vaults.
Compared to where we stood a few years ago, 3% annualised seems very measly. But the historical average return of a 60/40 portfolio is only around 3.6%.
So we’re a little sub-average (not an unusual feeling for me). But the real problem is I think I unwittingly anchored to the heady 7.3% annualised real return we’d notched up by December 2021.
As many commentators cautioned at the time, that was a castle in the sky, built on QE.
If then like me you became habituated to that kind of success, it’s probably past time to readjust and focus on a more realistic set of expectations.
A pain in the bonds
I’m not arguing amid all this that bonds should be ditched. Besides the fact that we’re passive investors who stick to the plan, the recession warnings are blaring and the ill-omen of an inverted yield curve hangs overhead:
Source: FT, UK government bond yields. 30 June 2023.
A quick bluffer’s guide to the inverted yield curve signal – Typically, long-dated government bonds have higher yields than shorter-dated maturities. But this normality can be upended by market demand for longer bonds if enough investors anticipate recession. Such buying takes yields at the long end of the curve below those at the short end. As indicated by the red boxes above.
We’ll be glad of our bonds if the US version of the inversion is correctly signalling a hard landing, as argued by Campbell Harvey of Research Affiliates:
Two negatives—the Fed’s mistaken characterization of inflation as transitory, and the Fed’s failure to pause rate hikes in early 2023 amid signs of moderating inflation—do not make a positive. The result is a banking and financial system, as well as a commercial real estate market, under stress. As a result, the odds of a hard landing have increased.
If a big recession kicks in then it’ll probably be our portfolio’s best chance to reverse some of the bond losses we suffered in 2022, as the market takes cover in their (relative!) safety.
Hence I’m back to being frozen. There’s no clear path forward and I remain in the passive investor’s super-position: poised for any eventuality because, really, nobody knows what’s coming next.
New transactions
Every quarter we place our coin onto the collection plate of the high church of global capitalism. [Jeez! Why can’t you just say ‘stock market’? – Ed]. Our tithe is split between seven funds according to our predetermined asset allocation.
We rebalance using Larry Swedroe’s 5/25 rule. That hasn’t been activated this quarter, so the trades play out like this:
UK equity
Vanguard FTSE UK All-Share Index Trust – OCF 0.06%
Fund identifier: GB00B3X7QG63
New purchase: £60
Buy 0.248 units @ £241.51
Target allocation: 5%
Developed world ex-UK equities
Vanguard FTSE Developed World ex-UK Equity Index Fund – OCF 0.14%
Fund identifier: GB00B59G4Q73
New purchase: £444
Buy 0.81 units @ £548.47
Target allocation: 37%
Global small cap equities
Vanguard Global Small-Cap Index Fund – OCF 0.29%
Fund identifier: IE00B3X1NT05
New purchase: £60
Buy 0.158 units @ £379.98
Target allocation: 5%
Emerging market equities
iShares Emerging Markets Equity Index Fund D – OCF 0.21%
Fund identifier: GB00B84DY642
New purchase: £96
Buy 54.425 units @ £1.76
Target allocation: 8%
Global property
iShares Environment & Low Carbon Tilt Real Estate Index Fund – OCF 0.17%
Fund identifier: GB00B5BFJG71
New purchase: £60
Buy 28.369 units @ £2.12
Target allocation: 5%
UK gilts
Vanguard UK Government Bond Index – OCF 0.12%
Fund identifier: IE00B1S75374
New purchase: £324
Buy 2.552 units @ £126.97
Target allocation: 27%
Royal London Short Duration Global Index-Linked Fund – OCF 0.27%
Fund identifier: GB00BD050F05
New purchase: £156
Buy 150.434 units @ £1.04
Dividends reinvested: £93.10 (Buy another 89.77 units)
Target allocation: 13%
New investment contribution = £1,200
Trading cost = £0
Take a look at our broker comparison table for your best investment account options. InvestEngine is currently cheapest if you’re happy to invest only in ETFs. Or learn more about choosing the cheapest stocks and shares ISA for your circumstances.
Average portfolio OCF = 0.16%
If this all seems too complicated check out our best multi-asset fund picks. These include all-in-one diversified portfolios, such as the Vanguard LifeStrategy funds.
Interested in tracking your own portfolio or using the Slow & Steady investment tracking spreadsheet? Our piece on portfolio tracking shows you how.
Finally, learn more about why we think most people are better off choosing passive vs active investing.
Take it steady,
The Accumulator
Quite impressive that the gilt fund is now back to its nominal price of ten years ago.
Impressive that the Royal London Short Duration Global Index Linked has, over its whole holding period, now outperformed all but one (Dev. World ex UK equity) asset class, including Global Small Caps. In light of discussions on the preceding Weekend Reading thread on ILGs, wondered if this might be an possible (lower duration risk) alternative to those?
Save as much as you can
Keep cost as low as possible
Live frugally
Stay the course
All under the investors direct control
The market via indexing will then do the business -sooner or later
That’s it
xxd09
Is the ‘worst case’ scenario for intermediate/long duration bonds in some ways harder to judge than that for equities?
It feels like the historical examples for equities are clearer than those for bonds, though maybe it comes back to age and what each of us have directly experienced in the past.
@TLI — Well as I’ve written several times, switching to the Royal London short linker fund was inspired thinking by @TA at the time.
Here was his thinking around that time, in 2016:
https://monevator.com/why-uk-inflation-linked-funds-may-not-protect-you-against-inflation/
I’m not sure which S&S update made the switch, maybe the first of 2017.
Anyway that switched worked because at the far lower duration than a typical UK linker fund in 2017, you’ve got the inflation protection without most of the interest rate risk. So the fund has ‘benefited’ from this burst of inflation (‘benefited’ in quotes because obviously it’ll have dinged those nominal returns in the table, like with any other fund) while at the same time it hasn’t been crushed by the 2022 rate bloodbath.
But that was then and this was now. If rates do continue to climb as you muse elsewhere on the site, then you’d still prefer to stay in short duration clearly. But if we’re nearer the end than the beginning now then it’s probably time to start adding longer-dated linkers and other gilts, as per Moguls this month. 🙂
The real yield on a ten-year linker was something like minus 2% in early 2017, versus positive near-1% today…
As I always say, it doesn’t have to be all or nothing. Somebody could begin to build duration with new money, or swap out 25% of their short duration fund, or many other options. 🙂
@ TLI – the annualised return is for the asset class rather than the specific fund (because the funds have changed occasionally over the years). Much of the index-linked gilt gain came from the run up of Vanguard’s UK linker index fund as yields fell. Switching out to the short-term fund before yields rose protected much of the winnings.
I think of the short-term linker fund as a wealth preserver. I wouldn’t bother with it if I was a young investor starting out.
@ Tetromino – the worst case for both asset classes is 100% wipeouts, Russian Revolution style. Here’s the worst bond market cave-in for the UK:
https://monevator.com/bond-market-crash/
Wade Pfau wrote this great post comparing worst case scenarios for most of the developed world. Bonds generally took longer to recover but there were some real disasters for equities too:
http://wpfau.blogspot.com/2014/01/greatest-hits-part-2-bond-market.html?m=1
@TI #5: combine RL short duration IL fund with INXG (16 yr) in equal admixture and it’s functional equivalent to an intermediate duration IL with a 65% UK weight and the rest tracking Bloomberg’s World Govt IL 1-10Y TR GBP index (RL having 30% tracking Bloomberg’s UK Govt IL 1-10Y TR GBP). Perhaps something like what we might in future find within a VLS fund (who overweight UK equity/ bonds)?
Apologies there. I should have typed @TA and not @TI on that one! And to think that for several years (after coming across Monevator in 2008) I thought that @TA and @TI were actually one person with a split passive versus active investing persona; a little bit like having an saintly passive angle and a tempting active devil on each side of your head!
Been a big fan for some time now. Binging on previous blogs/writings. I have a couple of newbie question?
(1)How do you compute annualized return whilst taking into account regular quarterly contribution?
(2) Is annualized return a good measure of how well an investment is doing? When people talk about stock historically average 7% return , is that the same as the annualised return?
Thanks Again for the great work!
@ CL – here’s how to work out annualised return:
https://monevator.com/portfolio-tracking-how-to-track-your-investments-using-a-money-weighted-return/
Lots of writers are pretty vague about what they mean by historical average returns. They should use annualised total returns – ideally inflation-adjusted i.e. real. Annualised returns are also known as geometric returns or CAGR.
Often though only nominal figures are available (which makes things look better than they are), or they’ll use arithmetic averages (very bad practice), or price returns. Most of the articles you’ll read about, say, the Japanese bear market, will only use price returns because it makes the story more exciting.
As a rule of thumb, the historical annualised real total return of the US stock market is about 6%, and about 5% for the developed world over the last 120 years. Much higher figures are either nominal or measuring a shorter timeframe. (Answers like this are why I get invited to all the parties.)
@ TLI – interesting. Vanguard Target Date funds have an inflation-linked component – from memory they use individual linkers for at least a portion of that, I assume to dampen down the long duration fund. Re: TA vs TI. There is no doubt in my mind that TI is the devil 😉
Inherent dilemmas for risk free asset(s): Go long duration and accept term risk for (generally) negative equities correlation, or go short duration for negible term risk but have next to no counterbalance? ILs for unexpected inflation, or keep it simple with conventional Bonds? UK Gilts, or go Global? Consensus that for Bonds it needs to be AA-AAA DM sovereign issuer hedged to £ (so no CBs, no EM debt and no fallen angle sovereign issuers). Beyond that, it’s a bit of a guess.
[Realise I was in fact replying to @TI #5, but should have replied to both @TI & to @TA #6. I’ll eventually get hang of this.]
@tetromino
I wouldn’t be too hard on the Gilts fund, you have a portfolio of diverse assets to cover many eventualities, obviously we only have one outcome.
If you looked back say 16 years ago the yield of a medium/long Gilt mix was around 5%, look back 7 years the yield was a little over 1%.
During the period 2007 -2016 you would have broadly got the 5% income you expected at the outset, plus a significant capital gain from the fall in interest rates.
At this point had you purchased this blend of medium/long gilts you would have expected a low 1% pa income, despite committing your money for 10 years or so at this low contractural interest rate. The possibility of interest rates rising would cause a significant fall in capital values, there was less room for interest rates to fall, the upside was limited.
It’s an asymmetric bet….
It transpires that interest rates have risen, you have had a substantial fall in the capital value.
I would suggest that Gilts were not particularly attractive in 2016, cash would have been a sensible alternative.
Where we are now is that Gilts are far more attractive, index linked Gilts as TI states have a positive real yield.
Bonds are interesting because you know so much about them at the time of purchase, even if you don’t know what comes next.
You can control the interest rate risk with duration, you can control credit risk, you can choose your currency exposure and finally you can choose index linked bonds or nominal bonds.
In 2016 there was always the possibility of deflation , deeply negative interest rates, the long duration Gilt would have done great then, it didn’t happen but surely that’s the idea of a diverse portfolio, something is always going to do relatively poorly.
Thanks TA, for reminding me of your bond crash article. I read it at the time and it’s a great example.
Perhaps I need to add ‘history lessons’ to my research list, and find some way to fully appreciate how exceptional it has been to have a 30 year trend of falling base rates.
@Hariseldon
Thanks, yes, all good and fair points.
One reason for my original comment is that I find it surprising how many general investment resources don’t go into enough depth on bonds for readers to understand all the points you raise. It’s a test I run now – pick up a book and just check whether it explains duration for beginner investors. Amazing how many don’t.
One thing that might be worth saying is that whilst your fund has grown, your fees have been low and have dropped over the years!
Zero fees to boot.
@tetromino
Equities appear more exciting than bonds, yet as time rolls on I increasingly find a Developed World Equity Index fund can suffice.
Bonds look complex but aren’t really once you have understood the basics, its worth the research.
You could look at the various articles here on Monevator, follow the links from one to another, one in depth post to cover all aspects would be fairly lengthy.
At a more advanced level there have been informative comments on Monevator from ZXSpectrum48K.
You can readily buy individual UK Government bonds (Gilts) both nominal and index linked instead of a fund of bonds, a fund is constantly buying new bonds to maintain its duration and this differs from holding an individual bond/s held to maturity ( if not replaced to keep the overall duration the same) its another lever you can pull.
@Hariseldon
Thanks, I’ve explored the Monevator archives and learnt from ZX too – to be clear, none of my comments about bond intros were aimed at Monevator, and the regularly recommended Hale and Kroijer resources do a good job on this topic as well.
Sorry if my flippant early comment caused some confusion. I just meant that it’s an interesting time and a chance to learn these bond lessons directly.
It’s a useful reminder of the classic trap we can fall into by being conditioned by events that are easy to recall or by recent events. I’d expect any amateur investor to quickly understand equity risks, but I can see how many people may not have appreciated bond duration risks in the same way. Almost Taleb’s point about not confusing volatility for risk.
And there’s that link back to the recent debate about exactly what’s active and passive, and when to actually take a view. I completely see how you would have judged gilts were not attractive at low rates, but there’s an awful lot of content out there saying the market rate must be right and just buy/rebalance without taking a view.
@tetromino — The problem with bonds and taking an active view was, with hindsight, we just lived through a truly historic boom and bust that probably doesn’t give us much information that we can usefully carry forward. (Except the general “be humble”, a trait shared by some of those who put their comments on the record over the years but by fewer pot-shot taking Internet commenters who are passing through 😉 ).
For instance look at this chump saying perhaps the bond market is *finally* going to get its comeuppance in… 2015:
https://monevator.com/bonds-crash-is-this-it/
Reader, the chump was me. Sure there are caveats in there, but I remember at the time I felt like if anything the post was overdue.
Well bonds kept on rallying for years after that, as rates continued to move down. By 2021 real terms losses were baked-in for linkers etc.
If you want to see how hard it was at the time to take a view (i.e. not coloured by hindsight bias!) have a look at @TA’s article from 2021:
https://monevator.com/are-bonds-a-good-investment/
Of course an unsympathetic quote extractor could make hay with that. TA does point out the worst gilt crashes have been in the order of 30% plus BUT he stresses that’s a rare event, and a 6% loss would be a more typical bad year. That looks complacent given we had one of the super-crashes in 2022. And of course it all now looks obvious.
But it wasn’t obvious. It was certainly a worse risk-reward than when I fretted about bonds in 2015, but I assure you bonds looked expensive and had been on a 25-year or thereabouts tear even by 2015! 🙂
In his article @TA is at pains to point out the worst bond crashes, and he stresses shortening duration is the best way to reduce interest rate risk, albeit at the cost of reducing the ability for bonds to cushion an equity price fall.
They didn’t do that in 2022, because the same thing crashed equities and bonds (interest rate rises). But equity markets crash for all sorts of reasons. We only have to think back to 2020 for that.
In short it was a very difficult time to be a balanced investor.
As you probably know I’m an active investor — and by the time the 2022 started I hadn’t held bonds for more than five minutes (I exaggerate for affect!) for years.
But I still had my worst year relative to the market in 2022 anyway, IIRC! Firstly my stocks plunged. Secondly I started adding to bonds and other fixed interest type stuff way too soon, and it kept falling. You lost money in almost everything for most of 2022.
Bottom line, investing is hard. Have your strategy. Try to capture the most upside you can for your risk tolerance, and know your limits — on many axis.
For most people passive investing and a balanced portfolio, diversified and perhaps tweaked at apparent market extremes if you are prepared to accept the consequences of being wrong sometimes, remains hard to argue against, bond-aggedon or no bond-aggedon 🙂
Cheers to all for the comments as always!
You can never go wrong at the short end of the gilt market except leave a little money on the table
The preferred way of individual investors investing in gilts used to be indexed linked NSI issues
This worked fine for all concerned
I’m at a loss knowing quite how to react. Following a corporate bond rout in 2020 where many of my bonds fell with UK equities, I consolidated and invested/switched into Vanguard UK Govt Index which increased 14.2% in approx. 8 weeks. I cashed in most of the gain, and switched the (small) balance into Vanguard Inflation Linked Gilts, which last year plummeted.
In 2019, I started switching everything except two active funds into Ls 60/40 and Van Ftse dev wld ex UK. Due to the fall in bonds, the Ls 60/40 increased less than 1% last quarter. I still have last years isa allowance in cash and intended to buy Ftse dev wld ex UK, but much of the info out there, states that gilts are now a good buy.
Having recently switched Fundsmith and SMT, I’m now fully passive, 75% equities, 24% bonds. In my mid-eighties with sufficient cash back-up, but as far as bonds go, I’m in the deep end, and left my arm bands in the locker.
Not as advice, but I would appreciate any input regarding UK gilts or similar, or perhaps a mix including equities.
Barney
@Barney#20: Thanks for sharing. Your recent experience, like those of so many with Gilts as a part of balanced portfolios, illustrates that there’s no risk free assets. That doesn’t, however, mean that there’s anything fundamentally wrong or right with Gilts (conventional or ILGs). They give a certain risk profile which may (or may not) compliment what you hope to achieve with the other assets in your portfolio. Cash/Conventional Bonds/other fixed income are subject to inflation risk. Equities (esp. Growth & Value)/Long(er) Bonds/Gold are impacted by interest rate risk. Corporate Bonds/EM Bonds have default risk. Equities (esp. Small Cap & Growth)/Commodities are affected by the business cycle. Some assets, at times, and in some scenarios, turn out to be less risky than others; but all assets have risks, just different ones. Unless you have a strong view, and good grounds for confidence in it, on the future pathways of each of inflation, rates and the economy; it may be best to just stick to your financial plan and to adapt it to any changes in your circumstances, whilst largely ignoring the macro picture. I appreciate that this may sound fatalistic, but there are only so many things about the future that we actually have knowledge of, and control over.
@Barney — I think Time Like Infinity has given you an excellent answer — in fact he’s in danger of doing us out of a job. 😉
It’s been a rough time for sure but while I can’t give personal financial advice at all, I would remind readers that behind the scenes the bonds in their bond funds are now generating more or less 5% nominal (gilts) and roughly 1% real (linkers). These compare to rates of 0% to -3% 18 months ago.
A lot has changed. Doesn’t mean we can’t see more losses in the short-term (today proved that!) but the good thing about bonds is they are pretty mathematical instruments. With higher starting yields we can look forward to higher (if still hardly exciting) returns.
@Time LI, & TI.
Many thanks for your response and input, which is much appreciated. Portfolio downturn doesn’t faze me too much, it’s part and parcel of investing. I like to think that where mainstream equities are concerned I can reasonably hold my own, or, google it. But for me, bonds are different territory and to be honest, I now have different priorities, such as making sure that I don’t do a backward somersault in the shower, followed by the splits.
As usual, another great and informative post, my thanks for all your input.
Barney
@ Barney – I agree that there’s something esoteric and counterintuitive about bonds that makes them difficult to grasp. These posts may help a bit:
https://monevator.com/bond-asset-classes/
https://monevator.com/rising-bond-yields-what-happens-to-bonds-when-interest-rates-rise/
https://monevator.com/bond-duration/
https://monevator.com/how-to-choose-a-bond-fund/
@ TA 24, many thanks, going through them now, it’s beginning to gel, a bit.
@TA. I’m still going through the links that you posted above, and due to my age etc I will go for short duration government bonds, my thinking being that 1.5/2% yield is good if it’s reasonably “safe”
Then I noticed that the UK Government Bond Index Fund in your slow and steady portfolio above, has taken a bit more than a haircut, more like a Kojak. Based on Vanguard’s records, £10k invested 5 years ago would now be worth £7769 down 22.34% and £10k invested 3 years ago would now be worth £6547 down 34.53%.
Not sure which turning to take, I’ll keep pondering, but I’m thinking that if they’ve dropped that much, now may be a good time.Who said bonds were mundane.