Financial planning lessons from 2021

As we look back on the second year stuck in a COVID world, there were plenty of items that unfolded that give us a reason to pause and learn. Some are new, some are old, but nevertheless there was something happening for everyone who chooses to learn from history.

The first item is that we can learn, once again, from Yogi Berra: “It ain’t over till it’s over!” When looking back at 2021, this can be applied to many matters: market rallies, interest rate increases or declines, COVID, political polarization, inflation, tax changes (or not), and life changes.

When we look at the investment charts for 2021, we see a few things. Generally speaking, when looked at in its entirety, 2021 was a very good year. Except for increased volatility and the fear of new variants shutting down economies across the globe, most markets trended up, with the U.S. leading the pack.

There were times when downward volatility caused many investors to wonder if the bottom was finally ready to fall out, but it didn’t. This is one major reason that clients have you to be thankful for … assuming that you have a good diversification strategy and don’t get too cute trying to time markets with frequent trades reacting to short-term charts or headline news.

Just when you think you have a handle on markets and their direction, things change. Take the end of 2021, for example: Most analysts were calling for yet another Santa Claus rally, but the omicron variant had another idea. The apparently weak yet highly contagious variant has caused Europe to go on lockdown again and sent fears through most major cities throughout the U.S. As of this writing, the endgame for omicron is still unknown, but I hope that it will go down as this entire pandemic … same as it ever was, with little financial interruption!

At the start of 2021, most proclaimed that this was the end of the decades-long bond rally and that rates would finally begin to climb. For moments during the year, it appeared that there was some truth to that forecast. But as the year wound down, the 10-year U.S. treasury was in the mid-to-low 1% range. And even at that, it was still the highest 10-year government bond rate in the developed world. Go figure: The world’s most advanced economy, chugging along quite nicely, and we had to pay more than any other nation to get our debt out on the streets.

I’ve been wrong for several years now, speculating when the decades-long rally in debt would end. Even though the Fed has signaled rate rises in 2022, don’t count your chickens from two perspectives. First is that the rate rises may not be as severe as you think. Second is that these rises, should they occur, may not be as damaging to the economy as you fear.

Nevertheless, it makes sense to look at your clients’ fixed-income holdings and be sure that their portfolio includes asset classes that fare better in a rising rate environment — namely, short duration, possibly high-yield, floating rates that have historically helped conservative investors during periods of rate rises and may help again should the interest rate cycle finally be changing.

Still a pandemic

As for COVID, there are two major surprises for many. First is that it is still lingering. Some reports suggest we may not see a meaningful end for another two years. But the second part is the lack of impact it has had on the economy. In the U.S. at least, the economy is chugging along, unemployment is low, corporate profits are high, and anyone who owns real estate is giddy over the value of their bricks and mortar.

Of course, what goes up must come down in one fashion or another, and there will be declines in the valuations of all of the aforementioned asset classes in years to come. The when part is the unknown.

As for housing, it is the procrastinators who lost out. Based on the statistics regarding household formation, it appears as if the bottom is not ready to fall out just yet. Household formation a decade ago was at its lowest point since World War II. The low formation statistics were based on the hangover from the banking crisis and the fact that new grads wanted to rent versus own as their older siblings had an unfavorable experience with housing and employment soon after their graduation.

But today, thanks to a robust economy and low interest rates, the formation of households continues at a robust pace. Top that off with a trend toward suburban migration as millennials build their families, and the housing market is as strong today as it ever was, with no slowdown in sight.

Political polarization remains alive and annoying. It seems as if nothing is easily accomplished in Washington these days. Parties chastise their members if they disagree even the slightest with what leadership wants to do. While this may make us look foolish at times on the world stage, it hasn’t yet changed the quality of life here in the U.S. and certainly hasn’t roiled financial markets. If you look beyond the U.S., it seems as if our political climate, for all of its idiosyncrasies, still works as well as or better than many other developed nations around the world. When you compare our government to less developed nations, it’s not even close. Just take a look at Venezuela, Argentina, Afghanistan and the African countries if you need to find a positive about our politics and polarization.

2021 may be the year where inflation came back, and clearly the supply chain and shutdown issues were a big part of that. To call it transitory, however, may be a bit naïve. Wages and housing are a big part of inflation, and both workers and landlords are loathe to take less than they took last year. For this, the inflation numbers we had grown accustomed to in the very low 1% range may be gone for a while. It takes a strong recession for both rents and wages to drop, and I don’t know anyone rooting for that to happen just to slow down the inflation statistics.

Just like everything else that seemed to change in 2021, the inflation increase hasn’t yet hurt financial markets. A sustained, above-average inflation rate may hurt at some point, but in the meantime companies have been able to raise their prices and not damage their profits due to rising costs across the board.

The value of planning

More than many years in recent memory, 2021 proved proactive and comprehensive wealth management to be as valuable as ever. That style of service for clients is critical to developing long, sustainable relationships. This is especially true if your clients have ever had any experiences with a firm that does not serve in that capacity. Going forward, you will either deliver that level of service or you will lose clients to those who do.

The proactive planner in 2021 was able to take advantage of the market volatility that we saw and execute some loss harvesting as the year went along. This came home to roost for planners who use a lot of mutual funds where distributions from many U.S. growth funds were quite robust in 2021. Without ever harvesting losses as they manifested, the buy-and-hold fund investor paid quite a tax bill due to the lack of proactive planning on behalf of their advisor.

All of the banter in 2021 about tax reform was nothing more than a noisy distraction. While we can all expect some sort of tax changes with each new administration in Washington, this year’s noise was extremely volatile. This was a year when simply talking about potential changes in your client newsletter was not enough. This was a year when forecasts and planning took center stage. Even though there were no major tax changes enacted in 2021, our clients are eternally grateful seeing firsthand the series of actions that we had queued up on their behalf in order to make the best of any potential changes.

2021 was another great year for Roth conversions. This now marks the 12th year in a row where we used up lower tax brackets for small Roth conversions. When I first started writing about this 10 years ago, many of my CPA colleagues gave me grief, asking if I understood the value of deferral. Now, with many wealthy clients holding large Roth accounts, I know we were right to do this.

If your firm was proactively in front of clients and all the noise about possible changes, use this as a template for how to serve going forward. Hard work and a genuine, deep concern for your clients never goes out of style.

The last lesson from 2021 is that stuff happens. Life throws curveballs at you all the time and may change at the drop of a hat on any given day. For that reason, I believe that not being proactive and holistic on behalf of your clients is negligence. Each and every year, be sure that their estate documents are up to snuff and ideal for their specific situation and objectives, that their insurances will protect them from the risks that you and they feel they face, that their businesses have a livable and workable succession plan, that the governance and day-to-day activities of their financial life are in line with the structures that they have established, and that they understand the potential range of expectations for their investment holdings.

I hope that you have a great 2022, and that your clients are able to maximize the benefit of all your firm can do for them.