There’s been a lot of press about an old investing adage “sell in May and go away”, and so it seemed a good idea to further explain the logic behind the strategy and consider why you may be better off ignoring it.
The theory behind “sell in May and go away” is that stocks historically underperform from May through October. If an investor sells their stock holdings in May and then waits until November to get back into the equity markets, then the theory is that they will outperform the investor who stays long throughout the year.
Winter months outperform Summer months, but they’re all up historically
And yes, there is data to support the strategy – the Dow Jones Industrial Average has gained an average 7.6% from November to April over the past 64 years, but has only increased 0.3% from May through October (according to the Stock Trader’s Almanac). But if you look at the Dow’s performance since its inception in 1896, you’d find annualized gains of 5.4% in the winter months versus 2% in the summer months. It seems like an awful lot of work and worry to avoid a 2% gain, don’t you think?
And there are other factors to consider if you are contemplating this strategy. First, there are the transaction costs. If you’re paying a per trade commission, then trading costs will bring down your total gain and really start to add up year after year. Second, selling will likely trigger unwanted tax consequences. And if you’re buying and selling your stocks every year, you’ll pay the ordinary income tax rate on those short-term gains – yikes! Third, theoretical performance does not often reflect actual returns. As investors, we always tend to underperform because of behavioral tendencies and/or bad timing.
Forget about bonds!
Another important point to consider is that for the theory to hold true, you have to put your money into something that is performing better than the stock market during that time period. That might prove very difficult to do these days, unless your tolerance for risk has miraculously changed overnight (and it likely hasn’t). And you can forget about bonds – they aren’t going to get you there.
For the long-term investor with a properly diversified portfolio, trying to time the market is a fool’s errand. If he or she had sold in May and gone away the past two years, then they would have missed out on some really nice gains. In both 2013 and 2014, the S&P 500 rose 2.1% in May alone, and gained 5.3% and 4.7%, respectively, from May though September.
Mind your allocation and enjoy your Summer!
With Memorial Day weekend upon us, it’s possible you’ll find yourself at a nice barbeque party with friends and someone will mention the “sell in May” strategy. Maybe he’s a broker (they love the strategy because they get paid commissions on all those trades), and maybe he’s not. Either way, you might want to just smile, nod politely, and enjoy your beer. Over the long-run, it’s going to cause you less stress to simply allocate your portfolio among the various asset classes (based on your objectives and goals, time horizon, and risk tolerance) and periodically rebalance to bring your portfolio back in line with your target allocation.