One classic scheme involves getting out of stocks between May and October. “Sell in May and go away” proponents argue that stocks have historically performed worse during these months than in the November-through-April period. Investing during the “weak” months is for dummies, the thinking goes; the real money is to be made during those strong months.
Like so many claims about investing, this one sounds intriguing until you examine it more closely. We’ll do that in a moment. But first, let’s review the principles of sound investing. Investing really requires just a few steps: develop a plan, create a good asset allocation, understand the risks involved, and then give the market a chance to do its job.
Keep that last step in mind: The market have historically gone up over time, despite temporary ups and downs, and if you’re consistently invested in it, you should ultimately make money if you believe in capitalism. Unfortunately, that’s not good enough for the would-be alchemists.
So let’s examine the sell-in-May strategy. One study, by Larry Swedroe, research director at BAM Alliance, found that it worked—at least it did from 1960 through 1979. Over that period, the market returned an average of 9.7% a year in November through April, beating the overall year by 2.8 percentage points. But Swedroe also found that, over the prior 33 years, the market’s year-round growth averaged 10.3%—more than 5 percentage points better than the supposedly stronger months of November through April.
It’s an artifact of historical research that you can find evidence to support either side of an argument. But there’s a deeper truth in investing, which is that past market performance doesn’t guarantee future performance. What happened last year might not recur this year. And if it doesn’t you’ll risk making the classic, costly mistake of selling low and buying high.
Then there are some inconvenient practical questions. Where, having cashed out of the market before May, do you put your money? Treasury bonds? CDs? If you’re not careful, your returns won’t even keep pace with inflation, and your wealth could shrink.
Also consider that selling your stocks and then buying them back can get expensive. Transaction fees can add up, but the bigger hit may be the short-term capital-gains taxes triggered by selling your entire stock portfolio every 12 months.
Another investing “shortcut” based on the calendar has to do with the “January effect.” It’s based on the idea that stock prices are more likely to rise each January than in other months. Why? Because each December, the theory postulates, investors sell losing stocks to offset capital gains elsewhere in their portfolios. All this selling pushes losing stocks even lower. In January, the underpriced shares are scooped up by bargain-hunting investors, and the demand drives up their prices.
Smart investors can supposedly take advantage of this annual ritual by buying stocks during the month of December and selling in late January, after the market has bid their prices back up.
Like all the calendar-based investing strategies, there’s some historical evidence to back this one up. But again, past market performance doesn’t guarantee future market performance. There’s no way to know if the January effect will occur this year or not. To invest on the assumption that it will is to gamble with your money in a market that recently has been quite volatile—and for what? A percentage point of outperformance? Taking on high risk for the potential of a relatively small return is the antithesis of sound investing. You wouldn’t bet your house in the hopes of winning a car.
Furthermore, as with the sell-in-May strategy, betting on January can get expensive because of trading fees and taxes.
Finally, a word about market efficiency. Economic theory holds that because of the amount of information available to all investors, the market tends to be very efficient in fairly valuing securities. If there really were reliable seasonal patterns in the market, millions of investors would attempt to profit from them. With the cat out of the bag, any advantage would disappear along with the seasonal phenomenon itself.
The bottom line: investors shouldn’t upend their long-term investment strategies to try and catch short-term returns. Investing is simple—and your best chance of success is to keep it that way.[/fullwidth_text]