Fourth Quarter 2021 – The fourth quarter of 2021 was a continuation of equity gains from the Covid recession early in 2020. US large company and small company gains (11%, 7.41%) substantially outperformed international (2.71%) for the quarter, 1-yr and 3-yr periods. Real estate had a full recovery year (41.85%), easily the best performing investment. Bonds had negative returns for the quarter and for the year reflective of interest rate changes. The 60/40 diversified portfolio allocation had good returns for all three periods.
Statistics are from Morningstar Advisor Workstation which are considered reliable.
What’s ahead for the market – Living with Covid – The effects of Covid are now being measured in the market. Inflation is likely cyclical and should remain at high levels until supplies match demand. Five million US workers have not returned to the workforce for a variety of reasons. Many “boomers,” the oldest of whom are now mid-70’s, are retiring. Others are suffering from Covid, looking for affordable daycare, and seeking better paying jobs. Worried parents are returning their children to school. The market has done well for the last couple of years, but concerns about the virus have led to Covid exhaustion. Fifty million in the US are still resisting vaccination and comprise the vast majority of sickness and hospitalizations from Covid.
Diversified Portfolios – Your portfolios will continue to be diversified across the asset classes as has been done consistently. This year you received nice returns from real estate (41.85%) and utilities (16.33%). Both sectors exceeded expectations at the beginning of the year by many analysts, and substantially outperformed bonds, which had losses for the year. This is the reason for diversification. The future is unknown and unknowable and the best long-term strategy has been wide diversification. Investments from world class managers at Dimensional, Vanguard, and PIMCO are in your investment base.
Quarterly reports – Your quarterly report has a new format which you will likely appreciate. There are two reports for the quarter:
· Portfolio Position Analysis – This report shows all your positions at quarter end allocated by asset class. Your yield (interest and dividends) is shown by the current value and by your cost. Your annual income is shown for each investment and the weight of the investment and of the asset class expressed as a percentage.
· Asset Class Performance – This compact report shows all relevant changes to your portfolio during the year by asset class. The flows are the net additions or (withdrawals) to your portfolios. The realized gains (losses) are for securities sold. Unrealized gains are gains not yet recognized. Interest and dividends are the amounts paid. Investment gain is from realized gains, unrealized gains, interest and dividends. This is the total return for the year on your investments. The annual IRR (internal rate of return) computes the net return for the year as a percentage.
These two reports provide relevant information about your portfolios in an easy-to-understand format. The focus of the reports is to show your current investments and the performance for the prior twelve-month period.
Bonds and Preferred Stocks – Many have had questions about bonds and preferred stocks which will be discussed here to add clarity to your investments in these asset classes.
Bonds – These investments are loans to a company or government. They have a due date for maturity, an interest rate and a credit rating. They are sold in denominations of $1,000. Usually, bonds pay their interest twice a year. Bonds will go up or down based upon changes in interest rates. The value of bonds is inverse to interest rate changes. This means when interest rates go up, the value of the bond goes down. When interest rates decline, the value of the bond goes up.
The easiest way to show this is with a $10,000 bond purchased with a 6% interest rate that will pay $600 per year of interest. If the market interest rate increase to 7%, a purchaser of the $10,000 bond will buy it at discount, so his/her yield is 7%. If an investor keeps the bond, he/she will continue to get $600 a year of interest. If the investor wants to sell the bond before maturity and market interest rates rises, the bond will be sold at a discount.
The interest on bonds is usually taxed as ordinary income, not the preferential capital gains rates. Municipal bond interest on certain issues is not taxed on your federal return, and not taxed on your state return if the bond is your state issue.
Bonds are usually held to maturity by most investors. Your yield at purchase is your yield for the investment.
Bonds are also purchased through mutual funds and ETFs. The same principals of increase/decrease in value due to interest rate changes apply.
Understanding how bond values work will help explain why you will still have an investment gain if the value of the bond decreases. Taking our $10,000, 6% bond, if the value of the bond decreases $200, you still receive your $600 of interest, so you have a 4% return on investment.
Preferred Stocks – These are investments in a company primarily for their dividends. They do not have equity participation, so the interest rates are usually higher than on stocks.
These investments are generally issued for a medium or long term, but they do have a call/redemption option by the issuer at the end of five years. Most have a par or stated value of $25. They have an interest rate and many have a credit rating. Dividend payments are usually made quarterly.
They are sold on stock exchanges like stocks and most are issued by banks and other financial institutions.
The yield on preferred stocks is the annual dividend paid divided by the preferred value. If purchased at par, you get the stated interest rate. If purchased at a premium, you receive a discounted interest return. At the redemption date, you get your $25 plus accrued dividends.
The strategy with these investments is to purchase them at par, or a discount to par. At a discount to par, your yield is higher than the stated rate. The strategy is also to hold the preferred stocks to maturity, or to call/redemption. Like bonds, the value of preferred stocks will go up or down during their lifetime, but the investor receives his dividends and his yield is the yield to redemption calculated at purchase.
The other advantage of preferred stocks is the dividends on most issues are taxed at capital gains rates for federal and income tax purposes.
Tax proposals – The proposed tax law changes as part of the Build Back Better legislation, which we reported on last quarter, are likely dead. With the 2021 year passing, the proposed $2 trillion spending package is stalled, at least in its current form. At this point President Biden is working with congressional Democrats on a compromised lower scale version of the original plan. Whether any major tax proposals will go through in the coming year is unknown.
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