There are many adages that have been followed in the stock market for decades. Some are based in truth, some are built of overwhelming investor opinion as a result of a statistical anomaly, and some have no factual basis at all. Nonetheless, they often drive the investment decisions made by the masses.
One of these old adages, “sell in May and go away,” suggests that investors should sell their stocks in May and seek alternative investment vehicles, coming back late in the year to take advantage of holiday-fueled gains. Although this adage is widely quoted, it leads to a bit of a conundrum for beginner investors.
If the power of investing comes from buy-and-hold investments that generate compound gains, why would you want to divest your portfolio for six months of the year? Would you really produce stronger average returns if you were to sell your stock holdings in May and wait until November to reinvest?
The fact of the matter is that the sell-in-May-and-go-away strategy is fundamentally flawed, but is there any kernel of truth to this popular adage?
The Idea Behind the Sell-in-May-and-Go-Away Theory
The idea behind the theory that investors should sell in May and go away is simple. Essentially, the adage suggests that declines generally take place in the May-to-October period. Therefore, by selling at the beginning of May, you can avoid declines experienced in the fall or summer months.
Those who follow the sell-in-May-and-go-away trading strategy believe that, due to low participation rates in the summer months, investments during these months are risky, ultimately resulting in decreasing average gains.
So, why are there believed to be fewer market participants in the months from May through October? There are a few reasons:
- It’s a Self-Fulfilling Prophecy. No matter whether you’re a beginner, intermediate, or expert investor, there’s a strong chance that you’ve come across this adage at some point. The sheer popularity of the idea makes it somewhat true by scaring some would-be market participants out of participation after May.
- Many People Take Vacations at This Time. The summer months are also when professionals are most likely to take their vacations. Experts who spend their days on Wall Street look forward to those few months a year when it’s somewhat acceptable to step away from the office for a couple of weeks. Because summer vacations are all the rage, many believe that vacationing equates to fewer investors participating in public markets.
- People Begin Saving for the Holidays. Finally, once the welcoming feel of the new year wears off, many in the middle class begin to look toward the future and plan for the holiday season that’s ahead. This planning generally includes increased saving and reduced consumer spending in the run-up to the holiday shopping season. As a result, it is believed that company revenues will underperform in May through October when compared to revenues in November through April. As a result, many expect a bear market in the summer months and a bull market in the winter months.
At the same time, there are some general beliefs that suggest that the winter and spring seasons are met with increased investor participation:
- Holiday Spending. The winter months are home to many holidays, some of which are the largest gift-giving and traveling holidays of the year. This is where you find Thanksgiving, Christmas, Hanukkah, New Year’s Eve and New Year’s Day, and Easter. As a result, spending during the “holiday season” is generally higher, leading to increasing revenues for companies and higher valuations for the stocks that represent them.
- New Year’s Resolutions. New Year’s Day is an important holiday for Americans. It marks the beginning of resolutions, often to improve both physical and financial health. As a result, tons of consumers who have not invested in the past begin to take an interest in the market, looking to build a stronger financial foundation on which to build their futures and leading to increased investor participation overall during the first quarter of the year.
- Speculation. As the new year comes into play, investors start to speculate with regard to the innovative new products and services that will be released in the year ahead. This speculation is believed to lead to more growth in market participants.
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Is There Any Truth To the Sell-in-May-and-Go-Away Theory?
Many in the investing community suggest that selling in May and not coming back for several months is a good idea, but does the historical data back up the theory? Are there really trends based on seasonality that will lead to predictable declines from May through November?
Well, yes and no. Much like the October Effect, selling in May and vanishing until late November or early December is a strategy that’s based on a kernel of truth, but greatly misses the mark. Here’s a chart breaking down what 92 years of historical data tells us about the flagship benchmark index in the United States, the S&P 500 index:
|Month||Years Up||Years Down||Average Monthly Returns|
The 6 Months From May Through November
As you can see from the chart above, one trend is immediately clear. If you sell in May and don’t come back, 92 years of historical data says that you’ll miss out on the month known for producing the largest market returns: July. That’s right, July has produced a whopping average return of 1.6% for the month.
Going a bit deeper into the market data, out of the six months from May through November, only one month had more years with negative returns than positive returns. Therefore, investing during these months would theoretically produce more gains than it would losses, if history continues to repeat itself.
Digging into the actual returns also shows that investments during these taboo months will likely result in positive returns. In fact, when you average the average monthly returns column across this six-month period, you’ll find that the average gains throughout this period work out to about 0.52% per month.
The 6 Months From December Through April
A brief look at the chart above suggests that there may be some truth to this adage after all. Three of the top four months by average S&P 500 index gains over the past 92 years take place within this six-month period. Moreover, there’s only one month in the period that the average returns over the past 92 years have been negative.
Moreover, every single month in this six-month period has a history consisting of more years in the green than years in the red.
Averaging the average monthly returns in the six-month period from December through April gives you a total average return per month of 0.73%. Comparing that to the 0.52% realized in the months from May through November shows that there may indeed be some truth to the adage.
Ultimately, investments in the United States equities market are more likely to produce slightly strong gains in the winter and spring months than in the summer and fall months, on average, suggesting that the seasonal pattern results in stronger gains from December through April than May through November.
Does This Mean You Should Divest All Your Equity Holdings in May?
So, should you indeed “sell in May and go away?” Absolutely not! Although it may be a good idea to rebalance your portfolio quarterly, the decision to sell any or all of your equity holdings shouldn’t be based simply on seasonality. Investment decisions should be based on detailed research, inclusive of the most up-to-date data no matter what season of the year it is.
Sure, there is some historical truth that some months of the year tend to see better performance than others, but that’s based on broad averages and measured in terms of the market as a whole. No matter what time of the year, or even the current condition of the market, there will always be gems that can prove to be excellent investment opportunities.
Instead of selling your assets based on seasonal volatility in the stock market, or what the S&P 500 index or Dow Jones Industrial Average may be doing at any given moment, it’s best to follow an investment strategy that includes rebalancing your portfolio on a quarterly basis. We’ll review this process shortly.
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Dangers Associated With the Sell-in-May-and-Go-Away Theory
Broad statements like “sell in May and go away” have the potential to come with portfolio-devastating consequences, especially when taken literally. The reason boils down to the real power of investing: compound gains.
Over time, your earnings start to earn money, which then earns more money. This is how small monthly contributions to a portfolio have the potential to turn into millions of dollars over the course of your lifetime.
If you take your money completely out of the market for six months out of each year, what you’re actually doing is robbing yourself of half of the compound gains you could be enjoying. When the market dips, it tends to be short-term — and is often followed by a significant recovery. Completely robbing yourself of compound gains because you’re fearful of the declines associated with a short-term dip in the market is a costly mistake.
Why the Average Investor Shouldn’t Try to Time the Market
There’s one big factor that lies at the heart of the “sell-in-May-and-go-away adage. The entire idea is based on timing the market. Market-timing is a dangerous prospect in and of itself.
The market ebbs and flows with consumer opinion, and predicting when it will ebb or when it will flow is extremely difficult. The best day traders, stock analysts, and investing gurus get it wrong sometimes, even though they have access to and a detailed understanding of some of the most complex and accurate tools available today.
Without serious experience in detailed technical and fundamental analysis, and a grasp of macroeconomics, attempting to time the market is akin to attempting to get a royal flush in a poker game. Sure, you’ll make a killing if things go well, but if things go wrong you’re going to lose — it’s a gamble.
The Alternative: Quarterly Rebalancing
A more sound alternative to selling in May and going away is to engage in regular portfolio rebalancing on an ongoing basis. Many choose to do this quarterly, making incremental changes four times per year rather than making dramatic moves in May and then again at the end of the year. The process of rebalancing includes the following:
- Calculate Returns. Start by combing through your portfolio and determining what your annualized rate of return has been on each of your holdings. While calculating the annualized rate of return may seem to be a daunting task, Key Bank solves that problem with their free Annual Rate of Return Calculator. This information also may be available through your brokerage.
- Compare Returns. Once you know the annualized returns on your investments, compare them to benchmarks to see how your investments are performing. It’s best to compare your investments to the most similar benchmarks. For example, if you’re looking at a tech stock within your portfolio, you may want to look at a few similar stocks in the sector as well as the Nasdaq Composite Index. If you’re looking into the performance of an exchange-traded fund (ETF) or a mutual fund, dive into the performance of the underlying asset to ensure that its returns are similar or outpacing the benchmark.
- Adjust as Needed To Meet Your Goals. After digging into your returns and comparing those to the returns seen by comparable benchmarks, you’ll be able to quickly determine which investments in your portfolio are underperforming. Simply sell these assets and consider either investing the funds into high performance stocks in your portfolio or using the funds to take part in new opportunities.
Although there is some truth to the idea that, historically, stocks do perform better during some parts of the year than others, market-timing is extremely difficult and often stumps even the most successful experts in the investing space.
Instead of worrying about which seasons stocks are slated to do best, it’s best to pay close attention to your investments all year round. Most importantly, make sure to take the time to occasionally rebalance your portfolio and stick to a solid investing strategy. You don’t have to always be trading, but making quarterly adjustments to your investment portfolio will likely serve you well.