A reader writes in, asking:
“We have an undesirably large sum in cash at the moment, nearly a third of our total financial assets. Interest rates can go nowhere but up, but who knows when? Is it best to invest this money right away, or given the current situation, should we wait until we know better what’s happening with the market and interest rates?”
To start with, I think it’s a mistake to think that interest rates have nowhere to go but up. Right now, interest rates are significantly higher than they were at the beginning of this year. (For example, as I write this, the yield on 10-year TIPS is a full 1.3% higher than it was on January 1, 2013.) Given that rates were lower just a handful of months ago, I don’t see why they couldn’t go that low again.
Unfortunately, with interest rates, we’ll never know where they’re headed next.* For example, imagine a scenario in which interest rates rise by 2% over the next year. That would put them at a more historically normal level, but there would be no reason they couldn’t rise further. In other words, no matter how long you wait to see what interest rates do, there’s no knowing what they’ll do next.
And, as it turns out, the same goes for the stock market — waiting doesn’t really give us any useful information about what the market will do in the future.
That is, neither stocks nor bonds become any more predictable (i.e., less risky) simply as a result of waiting to buy them. So, in my opinion, the primary question is simply: How much risk are you comfortable taking right now with this money? (And, for reference, I think it’s perfectly reasonable for investors with a low risk tolerance to include cash as a significant part of their long-term allocation.)
Once you have decided on the allocation you want to use for the long-haul, there tends to be little to gain from delaying your move toward that allocation — with, of course, the exception of situations in which the delay results in a predictable advantage, such as allowing you to make the switch at a lower cost due to a short-term capital gain becoming a long-term capital gain.
*Even the market as a whole tends to be unable to successfully predict interest rate movements. (See Figure 7 from this Vanguard research paper for a striking visual representation of just how often the market gets it wrong.)