What Should You Invest In For 2023?

2022 is now officially behind us. It was a difficult year for most investors, no matter what they invested in. The S&P 500 was down about 20% for the year. The Nasdaq was down more than 33%. The Dow was down almost 9%.

Usually an investment to go to for safety when stocks are down, even bonds and bond funds were down. Interest rates rose, and the yield on newly issued bonds increased, but that caused existing bonds and bond funds to generally decline in value throughout the year.

And if you invested in crypto, the top two digital assets, Bitcoin and Ethereum, were down about 64% and 68% respectively. Many other alt coins have fared even worse from 70% down to over 90% down from their all-time highs. To top it off, if you invested in Terra Luna, Terra USD, or had assets in Celsius, BlockFi, Voyager, or FTX, there's a chance you lost your entire investment.

So, yes, it's been a pretty rough year. What does 2023 hold for us investors? Where should we invest? Well, this isn't going to be an attempt at forecasting the markets for 2023. The odds are that any forecast would be wrong since markets are unpredictable, as evidenced by what happened in 2022. However, we can look at where markets are now and what is expected to happen from what is known, and then see what's possible. Let's take a look at the possibilities.

Equities, typically referred to as stocks, are what most investors think about first when they think about investments. Before we look at equities for 2023, let's look at equities in 2022.

There are 3 top indexes that are used to gauge the U.S. stock market: the S&P 500, the Nasdaq Composite, and the Dow Jones Industrial Average.

The S&P 500 is an index of about 500 large companies in the United States. When most investors think about the U.S. stock market, they think about the S&P 500. The Nasdaq Composite is an index of the Nasdaq stock exchange, which contains a large number of companies involved in technology. The Dow Jones Industrial Average (DJIA or Dow) is an index of the 30 most prominent companies in the United States.

All 3 major indexes were down in 2022. What was the reason? Mostly the move by investors from riskier assets to safer assets, initiated by the rise in interest rates. Equities derive their value from the current and expected future performance of the companies they represent. It is widely seen that with rising interest rates, the inversion of the bond yield curve (more on that later), and a reduction in cash injected into the financial system, that the economy could be in for a recession. If that happens, companies may not perform as well, and thus their stock values will decline. That possibility makes investors move from equities to other investments, or to even just hold cash and wait until they see a better opportunity.

So what should you do with equities in 2023? With equities, as measured by the S&P 500, down about 20% from an all-time high of about $4,818 a year ago, there are equity investments that may appear to be a buying opportunity right now. Before you make a purchase of equities though, first let's take a look at what we already know about 2023.

First, the Fed is still expected to increase interest rates even more. Right now, the Fed funds rate stands at a range from 4.25% to 4.5%. The Fed last month indicated that it sees interest rates at the end of 2023 to be around 5.1%, which means it will set the Fed funds rate to 5.0% to 5.25% at some point in 2023. Therefore, we can expect another 0.75% in interest rate hikes this year. Also, the Fed had previously set lower terminal interest rates in 2022, where it expected the interest rate to not exceed 4.6%. We're already just about there and the Fed still sees the need to raise interest rates higher. It's not out of the question that if inflation is not coming down enough that the Fed could set an even higher terminal interest rate for 2023 than 5.1%, where we would see more interest rate increases than currently expected.

Why are interest rates important? Higher interest rates make it more difficult for businesses to borrow money to develop and expand their business. That means we could see lower performance from various companies, and with that comes lower growth, and possibly a recession. A recession could also bring a decline in equities. That will make investors sell equities, which will also lower values.

Higher interest rates will also mean the yield of at least shorter duration bonds will go up. U.S. Treasury bonds, especially Treasury bills that are anywhere from 4 weeks to 12 months, are typically seen as "risk-free" investments, and with yields going up, and equity values possibly declining, investors see less need to take on the risk of equities and instead choose to invest in shorter duration bonds at first, then longer duration bonds once their yields increase.

Therefore, although equities appear to be a great buy right now, and they very well could be a great buy, there's still a possibility that we could see further declines in equity values in 2023. 

Even though equity values may decrease during the year, there are still stocks that pay dividends. Dividends are a way that companies pay out some of their profits to stockholders. If you own an actual stock directly or if you own a mutual fund or ETF that holds a stock that pays a dividend, you receive the dividend in your investment account. So although a particular stock or fund may decline 10%, it's possible that the actual overall amount of the decline of your account value could be considerably less than that.

Another thing to consider with investments in equities in the near future is growth versus value stocks. Until the Fed aggressively raised interest rates in 2022, the economy experienced historically low interest rates for more than a decade. And during that time, if the economy appeared to falter or be headed toward a recession, the Fed would step in and lower interest rates to keep it going. That was a great environment for growth stocks such as Tesla, Facebook, Google, Apple, and more. Prior to the Financial Crisis that started in 2008 and the Great Recession, it would be more likely that value investors could outperform growth investors by focusing on the fundamentals of companies instead of future potential. It's possible that in the near-term markets could favor value stocks again over growth stocks. There are a lot of factors at play, so it's impossible to predict that will be the case with any kind of certainty, but if interest stay high it's certainly a possibility. This is evidenced by the ability of Dimensional Fund Advisor's ability to outperform the S&P 500 with their value-based large cap funds, sometimes by almost 15%. Note that Escient Financial is a Dimensional advisor.

No one has a magic crystal ball to see what the future holds, so there's no way to know for sure if 2023 will see lower or higher equity values, but as you proceed with investing in them, you should be aware of the possibility in either direction. That's the same for any year you choose to put money into any investments.

Generally, Escient Financial aims for a long-term time horizon with equity investments, so if you do invest in equities right now, there's a good chance you'll eventually see positive returns, even if 2023 sees further declines. One way of reducing your risk when investing is to dollar-cost average your investment. You can find more on that in the Escient Financial Insights articles Lump-Sum Investing vs. Dollar-Cost Average - Part 1: Raw Returns, Lump-Sum Investing vs. Dollar-Cost Average - Part 2: Actual Outcomes, and Risk Management: Dollar-Cost Averaging.

Interestingly, where bonds are usually seen as an investment to fly to for safety when equities are declining, 2022 saw bonds as an investment that also saw large declines in value, right along with equities. The reason for this was the rapid pace of interest rate increases by the Fed in 2022. The Fed raised interest rates by 4.25% during 2022, including four consecutive 0.75% interest rate hikes, which is very rare. Rising interest rates means that new issues of bonds were providing a yield that was higher than bonds that already existed on the market. This resulted in what is called an inverted yield curve, where shorter-duration bonds offer a larger return yield than longer-duration bonds. Who would want to buy an old bond that pays a lower interest rate than a new bond? No one. Therefore, the value of existing bonds declined as interest rates rose. That also means that bond funds, which typically hold existing bonds until they rotate out to newer issues, also declined in value.

For 2023, interest rates are still expected to rise, so newer bond issues will still likely continue to offer a higher interest payment than existing bonds. This makes bonds, newer short-duration and long-duration, an attractive investment. Existing bonds, including those issued in 2022 with higher interest payments, could see declines in their value to keep their overall yields high, as long as the Fed continues to raise interest rates.

If you want to invest in bonds right now, keep in mind that you will always get back the face value of the bond. So if you buy a new $1,000 12-month Treasury bill that has a 4.69% yield, you'll still receive the $46.90 of interest and the $1,000 face value at the end of the 12 months as long as you hold it until maturity. If interest rates rise, the value of the bill may decline, but you'll receive less than the face value only if you sell it prior to maturity.

As mentioned above, interest rates rose throughout 2022, and will likely continue to rise in 2023, at least during the first half of the year. There's no way to be certain how much rates will rise at each Fed meeting (currently set for February 1, March 22, May 3, and June 14 for the first half of the year). High-yield savings accounts are currently offering interest rates as high as 3.85% APY. That's a lot higher than the 0.25% APY that was being offered by the same type of accounts a year ago. As the Fed continues to raise interest rates this year, the interest rate offered by high yield savings accounts could potentially climb even higher. Cash at a reputable bank that is FDIC insured is a pretty safe place to put your money, especially if it's money you think you may need in the near-term or are worried will lose value from declining equity or bond prices.

Whereas equities and bonds saw valuations decline in 2022, overall the year saw real estate values rise. Extra liquidity injected into the system and low interest rates during the pandemic saw a rapid and large increase in real estate values as many people opted to relocate from cities to suburbs and embrace a work-from-home lifestyle. Demand continued as prospective homebuyers tried to snap up property before interest rates rose too high. Only now, in the last couple months, are we beginning to see real estate values decline along with demand from a drop in the number of homebuyers willing or able to pay higher mortgage payments with the higher interest rates. Current real estate values are still higher, so the recent trend of declining values may continue in 2023 as interest rates continue to rise. Assuming the Fed makes a final interest rate hike during the first half of the year, and then maintains interest rates without any raises or drops afterward, we may see real estate values level off later in the year. Again, it's impossible to predict exactly what will happen. The Fed is basing its interest rate actions on data as it comes in, and that data and their reaction to it is also difficult, if not impossible, to predict.

Crypto had a tough year in 2022. Bitcoin was down 65% and Ethereum was down 68% for the year. Many other crypto assets were down up to over 90% for the year. Looking at Bitcoin and Ethereum from their all-time highs in November 2021, they are down about 76% and 75% respectively. That's after some recovery. At their lowest point in 2022, Bitcoin was actually down more than 77% and Ethereum was down more than 81%. Surprisingly, however, both Bitcoin and Ethereum have gone through worse bear markets. The 2018 crypto bear market saw Bitcoin down 84% and Ethereum down about 94% from their all-time highs at the time. For more insight into prior Bitcoin and crypto performance, see the Escient Financial Insights article Is Crypto a Scam?

In the crypto world, currently many supporters are promoting the idea that 2023 will see gains for crypto because Bitcoin has never seen two consecutive years of declines. It's important to remind investors that past performance is not a predictor or indication for future performance. Bitcoin is only about 13 years old, and crypto in general is still a new asset class. It's also important to point out that Bitcoin and crypto has not gone through a period of rising interest rates or seen a period with interest rates that are as high as they currently are. Bitcoin and crypto have also not gone through a recession before, and it's impossible to predict how it will react to a possible recession. Further, with the spate of fraud, hacks, and collapses that hit crypto in 2022, regulators are beginning to clamp down on the crypto industry. It's difficult to say what effect regulatory clarity and new laws will have on the crypto industry in 2023.

It is possible that Bitcoin, Ethereum, and/or other cryptocurrencies and digital assets will see gains in 2023, but there is also a possibility that the bear market will continue or that it will trade throughout the year near where it currently is. It's impossible to predict.

Escient Financial has always had the philosophy that crypto is a long-term investment. Because of its volatility, crypto is generally not a great investment for short-term time horizons for most investors. However, over a longer term of several years or more, crypto could be a great asset class that could potentially provide large gains. It is a riskier asset class though, and should be seen as a speculative investment at this time, so investors could potentially lose 100% of their investment in crypto and digital assets.

Before deciding where to invest your money in 2023, it's important to look at your financial situation and your goals, and especially how long you have to achieve those goals. Your risk tolerance is also important. This is why Escient Financial develops personalized financial plans and investment advice for clients that takes all of that (and more) into account.

Every individual's financial plan, and where they should invest their money, will be different. If you have a financial plan already, it's important to take the time to update it by reevaluating your current situation and your goals. Some goals may not be as important as they once were, while others may be more important now than before. There may even be new goals that you want to add to your plan.

The beginning of the year is a great time to establish a new financial plan or update an existing one, and Escient Financial is here to help you with that. Feel free to...