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Should You Invest in Cash or the Stock Market?

Updated: May 14

The debate over whether to invest in cash or the stock market didn't really exist a few years ago. Interest rates on investment grade, short-term credit were laughably low forcing yield-seeking investors reluctantly up the risk ladder.

Fast forward to today and we have money markets paying 4.5% and treasury bills eclipsing 5%. Retirees following the golden 4% rule are sitting pretty with risk-free yields exceeding their distribution rate. And those with stockpiles of cash waiting on the sidelines for the recession to hit continue to collect a healthy interest payment each month.

In this current rate environment, why not put all your money in cash and avoid the stock market altogether?

I get this question a lot, and it's a good one.

Cash vs Stocks Over Time

To address this, we first need to look at some market data, specifically comparing the historical performance of stocks and cash over time.

Going back to 2007 right before the Great Financial Crisis (GFC), you can see that the stock market more than 10x'd the annualized return on cash, as measured by 1-3 month T-bills.

Until about a year ago, investors were rewarded handsomely by being in the market as opposed to sitting in cash despite having to live through the mortgage crisis of 2008 and COVID-19. This makes sense considering interest rates were cut to zero post GFC and remained there until early 2022.

But since then, we've since experienced the fastest, steepest rate hike cycle in history. If we look more recently to when the Fed started raising rates in March of 2022, the data tell a different story.

Even though the market has recovered since its lows back in October, cash has outperformed stocks by a fairly wide margin in the near term.

Hindsight is 20/20

The past is never as clear as in the present.

Exchanging an all-stock portfolio for 1-month T-bills back in March of 2022 seems so obvious today, but the decision wasn't likely on many investors' radar at the beginning of 2022. Nor was increasing stock exposure when the economy was on the brink of collapse in February of 2009.

There's a common disclosure in the financial advisory business that goes something like this: "Past performance is no guarantee of future results." While this statement is undoubtedly true, it's somewhat incomplete.

The past can't predict the future, but it can aid our decision-making in the present by helping us identify market patterns and trends and assess the likelihood of what's to come.

Investing in Cash Today

Based on a long-term historical view, investing in stocks over cash today would appear to be the obvious choice. However, considering short-term treasury bonds are yielding three times the S&P with nearly zero risk, cash now looks like the better option on a risk-adjusted basis.

So, what should you do?


It's nearly impossible to address this question without context. The same goes for almost any other personal finance-related question, such as:

"Eric, should I invest in Nvidia?"

"Is it a bad idea to buy Bitcoin?"

"Are I bonds still worth it?"

I can give you answers based on my personal situation, but that's unlikely to add any value to you if you're not a 39-year-old business owner with a young family of four, and a high risk tolerance.

The only way to extract a valuable answer to the question of whether to invest in cash or the market is by adding personal context to the question. To do this, here are three considerations you may want to address first before making a final decision:

Should You Invest in Cash or Stocks?

1st Consideration. What are you investing for?

This simple question is often overshadowed by the latest and greatest financial trend garnering media attention. It doesn't matter if it's 5% T-bills or Bitcoin or A.I. The herd mentality feeds the fear of missing out (FOMO) that then morphs into careless financial decision-making.

Before plunging headfirst into a new investment idea, consider asking yourself what you're investing for. Retirement in 10 years? A downpayment on a vacation home? Getting clear on the bigger financial picture will make it easier for you to determine what course of action is best moving forward.

For example, a retiree with extra cash looking to earn more in their emergency fund might be a good candidate for T-bills or a high yield money market. Conversely, a 40-something tech executive with ample cash reserves focused on aggressive, long-term growth for retirement may be better off dollar-cost averaging into a globally diversified stock portfolio than opening a high yield savings account at Marcus.

Go deeper than surface level (i.e., should I invest in this or that) and consider bigger, more meaningful factors such as your specific financial goals, risk tolerance and time horizon when making any investment decision.

2nd Consideration. Where is the money coming from and why?

I don't care if you're buying CDs or call options, any purchase of marketable securities requires cash, and that cash has to come from somewhere. That could be from a bonus at work, from selling stocks or an unexpected inheritance.

Identifying the source of funds is an integral part of the decision-making process as it forces us to confront our overall financial objectives and question why we're considering this new prospective investment idea.

For example, if the cash you're looking to invest in either T-bills or stocks came from selling an S&P 500 index fund, simply ask yourself: Why am I doing this? Is it because you're (1) adjusting your risk profile from growth to moderate? (2) rebalancing your portfolio? (3) preparing for an upcoming expense? (4) locking in some gains and waiting for the recession to hit, then jumping back in the market when it drops? In this scenario, the first three are valid reasons for owning cash over stocks while (4), otherwise known as market-timing, is one of the fastest ways to lose money.

The source of funds for any potential investment should always be addressed and aligned with a why that's rooted in a disciplined, comprehensive investment strategy.

3rd Consideration. Reinvestment rate risk

The Fed has indicated it plans to raise rates at least one more time this year, making cash even more attractive. But if history is any guide, investors shouldn't get too comfortable with the current yield environment.

This chart above shows the federal funds rates dating back to 1955. The shaded parts indicate U.S. recessions which are almost always followed by a drop in rates.

Reinvestment rate risk is the risk of investing future cash flows from interest payments at lower rates. It's a risk that's more prevalent now than in recent years as short-term bonds are paying more than ones on the long end of the yield curve.

If we do enter into a full-blown recession, the Fed may be forced to cut interest rates. And when they do, they'll be cutting short-term rates which means yields on cash and T-bills will fall. The more severe the recession is, the more the Fed may need to cut.

Accordingly, a 5% T-bill today may not be paying the same level of interest two, three or four years from now. So when your 3-month T-bill matures in 90 days, you'll have to do something with that cash. And if rates fall, you won't be getting paid as much in the future.

Be sure to address reinvestment rate risk when considering cash or short-term treasury investments and have a plan for investing future cash flows.

Where To Go From Here?

Anytime I hear investors ask specific questions like, "Should I invest in cash instead of the market?", I know right away there's something deeper driving the inquiry. Almost always, it's driven by something emotional or uniquely personal to them.

Remember to assign your own context when presented with a new investment idea. T-bills may be a good fit for one type of investor and a bad fit for another.

Understand that not everything you hear in the media pertains to you and that no investment is exempt from risk, even cash. And never be afraid to challenge yourself by asking questions that will elicit the true "why" behind your intentions.

When in doubt, ask a professional for help.

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Image by Aaron Burden


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