Summary
In general, I believe 2021 was an improvement over 2020. COVID is still with us, but vaccines and healthcare workers, with improved knowledge about how to help the sick, made life feel somewhat normal again. Travel, even if somewhat limited, was possible and Costco had toilet paper in stock. Unfortunately, broken supply chains and staffing shortages were common throughout 2021 and will continue into 2022.
Inflation became a major topic of news headlines throughout the year. How high will it go? Answer: 6.9% annualized in CPI in November. Is it transitory? Answer: It depends on what the meaning of the word "transitory" is. For what it's worth, I don't expect hyperinflation. I believe what we're seeing is a result of a global pandemic, supply chain problems, and a labor shortage. Prices of goods and services will rise, and stay that way because no one lowers prices, but I doubt we'll see runaway inflation.
On the bright side, investors experienced a rare treat in 2021: The third straight year of big gains. The S&P 500 Index, a reasonable proxy for "The Market", had the following returns over the past three years:
2019: 31.49%
2020: 18.40%
2021: 28.71%
The last time investors experienced returns similar to this was just before the Dot-Com bubble burst in early 2000:
1995: 37.58%
1996: 22.96%
1997: 33.36%
1998: 28.58%
1999: 21.04%
An optimist will compare these periods and come to the conclusion we're in for another year of great returns. A pessimist will say a correction is imminent. Which one is correct? I don't know, but this is a good time to remind you that past performance is no guarantee of future returns.
Fourth Quarter 2021 Numbers
The average diversified U.S. stock fund, which is a better measure of how we invest than the S&P 500 or the Dow, gained nearly 7% during the fourth quarter. In total, the gain for the year was nearly 23%. This is especially impressive considering the average U.S. stock fund gained just over 19% in 2020 and over 28% in 2019. As I mentioned above, gains of ~20%+ for three years in a row are rare and may not necessarily continue. But they could! We'll find out in a little less than 12 months.
International stocks also performed well, just not as impressively as domestic stocks: The average diversified international stock fund gained a little over 2% during the fourth quarter, which translated to a gain of nearly 10% for the year.
Investors were cautious, pouring nearly $600 billion into bond funds during 2021. Unfortunately, the average intermediate-term bond fund lost 0.2% during the fourth quarter, which increased the overall loss to 1.3% for the year.
Returns By Broad Category
Can't read this? Here's a link to a PDF of this chart.
The chart above provides a high-level view of how the broad asset categories have fared annually from 2007 - 2021. The category titled "Asset Alloc." refers to a 60% stock/40% bond portfolio.
I love this chart and always look forward to seeing the updated version. Two takeaways:
Notice any patterns? If you answered "yes", we need to talk because your brain operates on a different level than mine. It's impossible to consistently predict which categories will perform best from year-to-year or month-to-month.
This chart is Exhibit A for why it's prudent to build diversified portfolios. Sadly, diversification means you're always having to say you're sorry because it's rare for every category to produce positive returns.
What's Next?
I dislike making predictions about the financial markets or the economy, but here are my five of my best guesses for the coming year:
Volatility in the financial markets will continue. Investors should stay calm and stick to their financial plan.
The Fed will raise interest rates 3-4 times during 2022.
With rising rates, investors may shift assets from growth stocks to traditional value stocks.
Inflation fears will continue to drive headlines, but will ultimately settle in around 3-4%.
Digital assets, AKA crypto, will continue to attract money from investors and scrutiny from regulators. The technology and its uses will evolve rapidly as some projects die and other emerge.
