There are seasons I look forward to during the year — the warm months for fishing and the cold months for hunting — and some I’d just as soon avoid — like hurricane season and allergy season. One of the questions I often hear from investors is whether there’s an ideal “investing season” that they should plan for each year. Is there any truth to the adage to “sell in May and go away,” and is the “October effect” really something to fear?
I’m happy to report that — unlike snow skiing or berry picking — investing is a year-round activity. In this blog, I’ll look at why these seasonal forecasts have become popular, and explain why I believe they should be ignored.
“Sell in May and go away” is a shopworn warning to investors that they should sell their stocks in May and get back into the market in November. Why? Because summer and early fall have a reputation for stock market losses, and some investors fear that their portfolios will experience a lull this time of year.
The “October effect” gets even more specific, branding the 10th month as a particular loser for stocks. Why? Because of these three October events:
- The Panic of 1907, which included multiple bank runs and a tidal wave of panic selling during a period of several weeks starting in mid-October 1907.
- The Crash of 1929, which included three notorious days of panic selling and severe market losses on Oct. 24, 28 and 29, 1929.
- Black Monday, when the Dow Jones Industrial Average lost nearly 22% in one day on Oct. 19, 1987.
Now that we know the reason these sayings became popular, let’s look at actual performance.
Examining monthly performance
The chart below illustrates the average monthly returns for the S&P 500 Index from May 2001 to April 2016. As you can see, during the notorious six-month period from May through October, three of those months actually averaged positive returns over the past 15 years, and five of those months outperformed January.
And October — supposedly the “marked month” for stocks — tallied the second-best performance out of all 12 months!
The problem with market timing
When investors let fear rather than facts guide their decisions, the results can be scary. Consider the chart below: In 2008, at the depth of the global financial crisis, equity investors fled for the exits, but it wasn’t until 2013 that investors put meaningful amounts of capital back into the stock market. As a result, many of them missed the market’s turnaround, which started in 2009,1 and bought back in after stocks had risen. (In other words, they sold low and bought higher).
If investors can’t accurately time the market over a matter of years, trying to do so from month-to-month is a virtually impossible task.
Equity flows didn’t turn solidly positive until well after the market’s 2009 turnaround
How patience, and diversification, can help
If you’re considering a seasonal approach to investing, consider these two points:
- Fear can cause you to do the wrong thing at the wrong time. Piling into investments during the good times and selling them during the bad times can result in a “return gap” in which investors’ results may not match asset class returns. A study by Morningstar found that in the 10-year period through 2014, the average US stock fund returned 7.47%, but the average US stock investor earned 0.98% less.2 The study attributes that loss to investor behavior.
- Sticking to a diversified portfolio may help ease the return gap. It’s inevitable that markets are going to rise and fall over time. As we’ve seen, trying to time the market often results in selling low and buying high. But retreating to cash doesn’t offer the growth potential that most investors may need to retire. So what’s the answer? There’s no magic bullet in investing, but patiently sticking to a diversified asset allocation plan may help remove the temptation to do the wrong thing at the wrong time and potentially reduce the return gap that comes from poor decision-making. Remember the -0.98% return gap that US stock investors experienced over 10 years? Morningstar found that the return gap for investors in allocation funds, which generally include multiple asset classes, was only -0.2% over the same time period.2
Taking a long-term view
Although it would be nice to have market losses restrict themselves to one particular month, that’s not the way the world works. I believe investors should retain a long-term view of the market and stay focused on their ultimate goals. It’s much easier to stay the course if you have a properly diversified portfolio that’s designed to meet your financial goals in a variety of markets, from January to December.
Diversification does not guarantee profit or eliminate the risk of loss.
1 S&P 500 returns from May 2001, through April 2016 (Source, Bloomberg LP)
2 Source: Morningstar, “Mind the Gap 2015,” as of Dec. 31, 2014. Return gaps reflect asset-weighted investor return less average total return.
In general, stock values fluctuate, sometimes widely, in response to activities specific to the company as well as general market, economic and political conditions.
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