Market Mythbusters: “Sell in May and Go Away”

There’s a belief among investors that you can make above-average returns by only owning stocks from November to April. This strategy is more well-known as Sell in May and Go Away.

The problem: it isn’t true.

It appears that this saying is merely a market myth. And today, like Adam Savage and Jamie Hyneman on the Discovery channel, we’re going to bust that myth.

The Myth

The Sell in May strategy revolves around the idea that stocks tend to perform poorly during the summer period therefore it’s best to sell off at the start of May, moving your assets into cash, and then buying in again in the autumn.

Let’s delve into this popular investment adage to see just where it falls.

The Bust

When you evaluate an investment strategy you always want to compare it to something. How did the strategy do versus the S&P 500, for example. That should be the gold standard. How many more percentage points could you get using a particular strategy over simply investing in the S&P500 and employing the tried and tested buy-and-hold strategy?

Luckily, we can go one step further.

s1Source: CXO Advisory Group, 2013

Take a look at the chart above. It shows the results of three different portfolio strategies.

  • The first is a buy and hold strategy. You buy once and never sell; that’s the green line.
  • The second is the ‘Sell In May, Go Away’ strategy and is represented by the red line; put another way, you hold stocks from November to April.
  • The third line (blue) is what we’ll call it the ‘Buy in May’ strategy. It represents an investor holding stocks from May to October (the inverse of the Sell in May strategy.

Clearly over a very long time horizon, the buy and hold strategy utterly demolishes the other tactics. $1 in 1871 would have grown to nearly $1000 using the Sell in May strategy. That same dollar would have ballooned to nearly $200,000(!!!) using a simple buy and hold strategy.

What’s interesting to note is that the Sell in May strategy handily beat the Buy in May strategy – which could be the reason the whole Sell in May message came to life in the first place. The evidence seems to indicate that, historically, the summer months have experienced lower returns than the rest of the year.

Take a gander at the average returns by month from 60 years of data on the S&P500. This tells us on average, how well the S&P 500 does in a given month.

s2

Source: agorapus.com

Based on average returns it seems pretty clear. The best months are usually November and December, while the worst months tend to be February, May, June, August and September. Following a Sell in May strategy would seem to shield you from the worst of it during the summer months; i.e. you’d avoid May, June, August and September.

So why then, doesn’t this strategy beat a buy-and-hold investor? If the summer months suck for investing, then wouldn’t we.. shouldn’t we come out ahead by avoiding them? What’s going on?

Luckily, we’re not the first to ask this question…

s3

The CXO Advisory Group tested the three investment strategies we talked about earlier, under a number of different assumptions. The figure above shows the returns for each strategy under each assumption.

  • Baseline: This is the scenario we looked at earlier; remember when we saw buy-and-hold dominate the other two strategies. It represents the real-world results.
  • Frictionless: Assumes there are no trading costs associated with buying and selling stocks.
  • No dividends: Assumes dividends are not paid out nor reinvested into your portfolio
  • Frictionless and no dividends: Assumes both previous assumptions combined
  • No return on cash: Assumes you don’t earn any interest from leaving your cash in some generic savings account

What we learn is that the only scenario where a Sell in May strategy outperforms Buy-and-Hold is in the ‘frictionless and no dividends’… representing a world where no trading costs exist and dividends are neither paid out nor reinvested.

The Truth

Unfortunately, such a world doesn’t exist. It does cost to both buy and sell stocks. Every time you incur costs trading, you are eating into your potential returns.

Also there’s a lot to be said about the returns, and especially the dividends, you are missing out on when you choose to not participate in the market from May to October. Economists often talk about opportunity cost, which is the cost you bear from engaging in any activity. Imagine you are a freelance consultant earning $50 an hour. If you take an hour out of your workday to watch a movie then you have lost $50 (the amount you could have earned by working) plus whatever you paid for the movie.

Opportunity cost can basically be boiled down to this question: “What is your next-best alternative?”

If by taking your money out of the market you have to consider, what is the next-best alternative for my money? Do I keep it in my Bank of America checking account or in a hole in my mattress, where the return is 0%?

If by investing during the summer months and reinvesting my dividends and NOT incurring transaction costs I can return 3-5% then isn’t that way better than 0%?

It is.

So in the end a better strategy is to buy and hold while avoiding the temptation to time the market. Less mess, less fuss.

Ahem…

MYTH BUSTED!

Let us know below if there are any other market myths you’d like us to take a crack at busting.

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