2021 was a strong year for the stock market as a whole. It was also a good year for investors with diversified asset allocations which match their risk tolerance. At the extreme if you invested solely in the Standard and Poor’s market index your total return for 2021 was 28.7%, well above the long-term average return of 10% for large capitalization stocks as shown in the table below. Standard and Poor’s indices are available to all at https://www.spglobal.com/en/.
S&P also provides indices based on diversified portfolios for varying types of risk. These portfolios assume different percentages of investments in fixed income (e.g., bonds) and equities (e.g., stocks). Also within stocks and bonds they assume a diversified portfolio including various types of stocks (large cap, mid cap and small cap stocks as well as domestic versus international stocks) and various types of bonds. S&P defined an aggressive portfolio as one in which 80% of the portfolio is invested in the different types of stocks in proportion to each type’s market size and 20% is invested in a similarly diversified bond portfolio. Such a portfolio earned 15.6% in 2021. A 60% equity/40% fixed income portfolio which S&P classifies as growth earned 11.4%. A more moderate portfolio earned 7.1% while a conservative portfolio of primarily bonds earned 5%. Note that for these indices S&P uses ETFs to determine the returns so they represent returns that could have been earned net of ETF expenses. Ten year average returns were also strong across all risk levels. Note that risk measured as the standard deviation of returns (variability) is higher as you move up the risk levels. Past history is no guarantee of future performance and this is especially true in the markets. In fact, after particularly good years like 2021 future expected returns are generally lower as the price has run up higher than normal and relative to underlying earnings and cash flow. Given a particularly good few years of market returns and the current valuation of the market, returns for the next 5 to 10 years can be expected to be below recent and long-term history.
It is also good to drill down and examine individual type of investments within equities, fixed income and alternative investments. I like to do this by looking at the returns of low cost exchange traded funds (ETFs) representing each type of investment. The table below shows returns by investment type (also known as asset class or sub-asset classes).
From this data we see that medium sized and small sized public companies also did extremely well in 2021 as well as on average over the last 10 years. Over a longer 15-year period their returns were very close together at just over 10%. International stocks in developed markets did reasonably well but much lower than US markets. Emerging market stocks (stocks from developing countries like India, Indonesia and the like had very low returns as their economies struggled during the pandemic. With rising inflation and interest rates, bonds did not do well. Bonds lose value when rates rise. As would be expected, the exception was inflation protected bonds with an almost 6% return in 2021. Gold was the lowest performer with a 4% loss in 2021. Real estate (Through real estate investment trusts) were the big winner at an over 44% return.
All in all, 2021 was a good year. However, we should not expect these extraordinary returns to continue. Given high valuations, in particular for large growth oriented stocks, I would expected muted returns for large stocks in the coming 5 years. Within large stocks, I would expect value or growth at a reasonable price stocks to outperform purely growth oriented stocks. I would also expect small, mid cap, international and developed market stocks to do better than large cap stocks, again over a 5 year period (anything can happen in a year!). Given expectations for rising interest rates bonds will not likely do well and shorter term bonds should do better than longer term bonds. Inflation protected bonds and other types of bonds such as floating rate bonds should do better. As noted in my other blogs posts though you should be diversified across many asset classes including some allocation to growth oriented stocks. Do not put all of your eggs in one basket and make sure your overall allocation is one that matches your ability and desire to take risk.