Money Goes to Money: Investment Results for 2021

It is a bit of a paradox that while Americans were battling the second year of an historic pandemic in 2021, the stock market was booming, and the economy was roaring back to life. Certainly, demand for goods and services was exploding, as vaccines rolled out and millions returned to work. Unfortunately, however, with multiple waves and variants of COVID-19, the numbers of cases and hospitalizations shot back up to levels not even seen in 2020. Eventually, those numbers went down – only to rise again, in time, and reach even higher levels. And yet, despite a constant stream of supply chain disruptions, despite monumental labor shortages, and against a backdrop of hundreds of thousands of deaths, the U.S. economy managed to bounce back.

The economy and the stock market are two different things, as economists have noted before. In the most extreme example of simplification, one measures the amount of human activity, while the other measures the amount of profit. And yet, of course, they are intricately related. Increasing economic activity naturally leads to more profits, and more profits beget even greater economic activity. So how did the Gross Domestic Product (GDP) for the United States fare in 2021? According to the U.S. Department of Commerce, the country’s total economic output grew by 5.7% in 2021. That number is quite high compared to other years in recent history – in fact, that was the greatest GDP expansion seen in approximately 40 years! Keep in mind, the average rate of economic expansion over the past 20 years has been about 2.1%. The number for 2021 compares to minus 3.4% for the preceding year – yes, indeed, the total economic output of the world’s largest economy shrank by 3.4% in 2020.

If the U.S. economy was shifting into overdrive in 2021, it only made sense that the stock market was soaring to new heights. It turns out that the Standard and Poor’s 500 Index (“the S&P 500”) achieved an increase of 26.89% in 2021! This is the most widely-quoted American stock index, but other familiar indices also saw significant gains – the Dow Jones 30 (“the Dow”) increased by 18.73%, and the NASDAQ index increased 21.39%. This is all good news, of course, for personal portfolios and individual retirement plans that are invested in mainstream companies. It’s also good for trust portfolios, gift annuity funds, and many endowments in the non-profit sector.

But we should keep in mind that with fiduciary relationships, portfolios are not invested entirely in stocks. The prudent investor concept requires a trustee or asset manager to maintain a diversified portfolio – the trustee/asset manager must balance the needs of current beneficiaries against the needs of future beneficiaries. We typically see a charitable remainder trust (CRT), a pooled income fund, or a gift annuity pool invested at least in bonds as well as stocks. The most widely quoted bond index is the Bloomberg Barclays Aggregate Bond Index, which had a return of -1.54% in 2021. Why would the bond side of a typical investment portfolio have a negative return, when the stock side’s performance was so spectacular?

The pattern is predictable in periods of rising interest rates – existing bonds have already been written at certain rates of interest, and they lose value as newer bonds are issued with higher interest rates. Add inflation to the mix – the U.S. experienced a 7.0% rate of inflation in 2021 – the greatest loss of purchasing power in 40 years – and you have a recipe for significant losses in fixed income investments. The negative bond results in turn have a depressing effect on the overall blended investment performance of a typical trust portfolio.

In our previous modeling, we have shown the blended results of the two afore-mentioned indices – the S&P 500 and the Bloomberg Barclays Aggregate Bond Index. Certainly, there are other asset classes to be found in the occasional trust portfolio – we’re seeing a few more examples of shares of precious metals and commodities, as well as shares of real estate funds – but most investment portfolios we encounter in our planned giving work revolve around a simple asset mix of stocks, bonds, and cash. For simplicity, we’ll assume again that our prototypical trust portfolio holds 50% equities and 50% bonds.

For our theoretical trust portfolio in 2021, we have a blended investment performance of 12.68%. That’s the effect of the slightly negative bond return combined with the positive stock return. And we should note, that is a lower result than the average return in the real world – in most trust portfolios, the equity side would more likely be around 60% or 65%. With the higher equity allocation and the smaller bond allocation, we would have a blended performance of 16% or 17%, respectively.

More important than a single year’s investment return, however, are the historical averages going back over 25 years to 1997. The average long-term investment performance on this over-simplified, overly conservative theoretical trust portfolio for the 25 years from 1997 to 2021 was 8.0%. The averages for the last 20- and 15-year spans dipped slightly under 8%, but again, we are oversimplifying the examples and erring on the side of caution. The main point is that, with very conservative estimates over long ranges of time, we see total investment returns annualized at anywhere from 7.51% to 10.57%. With these real-world results, anyone could simply purchase shares of index mutual funds, hold them over a long period of time, and achieve a successful outcome of a split-interest gift arrangement.

We wanted to revisit this topic again after another calendar year has closed, because these results are highly relevant to our work as planned giving professionals. One of the most difficult issues we see our clients struggling with is projecting long-term investment performance for trusts and other investment portfolios. We have maintained a default annual investment rate of return assumption at 8% in our planned giving software, and we frequently encounter questions whether that default assumption is reasonable.

When running projections, of course, there is no right or wrong; no one can predict the future. In any fiduciary relationship, the risk tolerance must be determined for all affected parties, and real-world investment choices should be made accordingly. At PG Calc, we want our clients to understand the general context of long-term investment results, based on industry data, as they are applied to standardized simulations. We believe it is possible to model trust investment portfolios in a careful, thoughtful, and cautious manner, using solid assumptions, resulting in reasonable estimates of outcomes for split-interest gift plans.