How Investors Can Navigate Uncooperative Markets And Maintain Optimism for 2023

2022 was a tough time for investors, as difficult equity and debt markets stung account balances. As we enter a new year, there is hope and optimism for better returns, tempered by some considerable risks for investors to navigate.

On the positive side, it appears that inflation in the U.S. has peaked; however, inflation remains historically high, with no guarantee that the pace of rate hikes will completely prevent future price flare-ups. Meanwhile, geopolitical events continue to fuel uncertainty, with no imminent resolution to Russia’s ongoing invasion of Ukraine, and the uncertain impact of China’s economy reopening amid easing Covid restrictions. The Federal Reserve is still raising rates, albeit at a slowing pace, and investors have generally been wise to avoid “fighting the Fed.” It is unlikely rates will fall any time over the next year.

All of this adds up to a challenging environment for investors already reeling from last year. Unfortunately, we can’t control the markets, but we can take some actions to ensure that this year isn’t a disaster for our portfolios. We can work towards building wealth and ensuring our financial goals are met, even in uncooperative markets.

When the environment for returns is not as favorable as we would hope, the importance of basic investing practices increases. There won’t be a single factor or portfolio trick that will lead to investment success in 2023. But paying attention to the (sometimes tedious) details of sound portfolio management and personal financial hygiene can give us a better chance at success than trying to time the bottom of the market or chasing returns of a hot company or industry.

Re-evaluate your risk tolerance

A good activity to start the year is an evaluation of our own risk tolerance, and how that tolerance for market volatility may have changed after a down year. It can be a helpful thought experiment to imagine another year like the last and consider the impact it would have on our finances, both fiscally and psychologically.

We don’t want to overreact either, so it is equally important to understand the impact of shedding too much risk in our portfolio, particularly when the market may only eke out moderate gains on the upside. So, consider what a year would look like if the market advanced, but your portfolio – invested too cautiously – lagged substantially, perhaps even declined in inflationary terms.

Finding a tolerable allocation of equities, debt, and cash can help you stay invested for the long term. And we want to stay invested. Even the sharpest investors cannot reliably predict when the market turns, yet missing out on positive market days can be harmful, especially when we are in a lower-return environment. Stay invested but do so in a way that fits your risk tolerance.

Keep an eye on costs

The effect of the fees and charges you pay for your investment management becomes magnified when the markets are down or treading water. Luckily, there are more choices and tools available today to keep trading costs low than there were even a decade ago. A lower return environment is a great opportunity to assess our investment costs and explore whether we are taking advantage of the best deals for managing our assets.

Mutual fund management fees – The amount of your mutual fund investment devoted to the costs of managing the underlying portfolio is expressed as the expense ratio. The expense ratio can differ substantially depending on the fund manager and the type of mutual fund or ETF.

The rise in popularity of passively managed index funds and ETFs over the last decade helped fuel a price war among some of the largest asset managers, resulting in extremely low expense ratios for some index funds and ETFs.

That doesn’t mean we should blindly invest in the lowest-cost funds. The near-zero expense ratios may have drawbacks concerning fund management practices, and there may be valid reasons to invest in higher-cost strategies. But as we evaluate mutual funds and ETFs, we must compare the expense ratio to similarly managed funds to ensure we keep costs reasonable. Price compression that has led to lower expense ratios is a positive development for investors, but many overpriced funds still exist and may not be worth the drag on returns compared to a cost-efficient index fund.

Trading fees or commissions – The price you pay when you sell a stock, option, or other types of securities – are an often-unavoidable cost of investing. But fees can become a drag on returns, especially for frequent traders who rely on their brokers for advice or to execute trades. Similar to mutual fund and ETF expense ratios, trade commissions have come under competitive pressure in the last decade, lowering or even eliminating trading fees. If you haven’t compared your broker’s fee schedule to other options lately, now is a great time to do so. Like mutual funds, you’ll want to weigh the value of the services you receive at your brokerage when considering the cost of trading.

Taxes – No one likes to pay more taxes than necessary, and tax missteps can be even more painful when returns are hard to come by. Ensure that you invest as much as possible in tax-deferred retirement accounts like IRAs and 401ks. When investing in a taxable account, be mindful of selling stocks within a year of purchase, as gains are taxed at your ordinary income rate; rather, than the generally lower long-term capital gains taxes. It’s also a good idea to speak to a tax advisor before any major portfolio transactions, such as changing brokerages, to understand any potential tax consequences before incurring them.

Other fees and expenses – A myriad of other expenses may eat away at your portfolio if you are not diligent. Be mindful of short-term redemption fees in mutual funds. Avoid paying a “load” or sales commission on a mutual fund – there are usually cheaper alternatives for the same investment. 

Paying for investment advice can be a prudent decision, but you may also want to consider free sources of advice, including investing in low-cost robo-advisor offerings. In fact, some robo-advisor products can help manage tax costs through tax-loss harvesting options.

Invest in healthy companies

Companies with a healthy balance sheet that can generate cash in challenging conditions are usually safe bets and often hold up the best in a recession. 

For our fixed-income (bond) allocation, you’ll want to ensure that the default risk is low, especially when economic conditions are deteriorating. Investors can evaluate this risk by researching a company’s interest rate coverage. If a company needs to devote a high portion of its free cash flow to cover interest payments, the likelihood of a default is higher. A company with sizable debt due in the near term should also be evaluated more carefully. Prioritize companies with plenty of cash to cover their obligations.

On the equity side, seeking companies with a history of solid dividend growth can help ensure that individuals are investing in companies with strong capital stewardship, and receiving some real return on their investment even if markets fall. Again, it is important to evaluate whether a company can afford to pay and grow its dividend and whether the company is not reacting under pressure to keep dividends high, risking solvency.

These investment strategies can be found in many actively managed mutual funds. Look for fixed-income mutual funds that evaluate and prioritize credit quality and invest in equity funds that prioritize dividend growth. As mentioned previously, compare mutual fund expense ratios to ensure the fees are competitive.

Exposure to what’s next

Following these principles and staying patient and diversified can help keep investors focused on what’s important – long-term growth. Hopefully, investors will be prudently allocated and see the market turn around sometime in 2023, but we should plan for a range of possibilities. That way, we can avoid reacting to the short-term noise, and there looks to be plenty of noise this next year.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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