Is it Better to Sell in May and Go Away?

Happy month of May! This is certainly one of my favorite months of the year. May is sort of the unofficial beginning of summer. (But isn’t it always summer here in Southern California, isn’t it?) What do you think of when May rolls around? I always think about the first Saturday in May. Typically, that’s when the Berkshire Hathaway annual shareholders meeting and the first leg of the triple crown, the Kentucky Derby take place. (Although this year, the Berkshire meeting took place yesterday, April 30th.)

For many investors, May is the time to think about the old stock market adage: Sell in May and stay away. The thinking here  is based on the assumption that stock market returns from May through October, the summer months, have historically been poor and that investors are better off sitting on the sidelines in cash during those months and not getting back into the market until November.

The Worst of Times
Does this theory make sense? Is there validity in this thinking? Well, if you are only in the stock market from November through May, you would miss out on October’s gains and losses. Two particular Octobers have been noteworthy for substantial declines: 1929 and 1987. In late October, 1929, on Monday and Tuesday, the 28th and 29th, the Dow Jones Industrial average declined by nearly 13% and 12%, respectively. Similarly,on October 19, 1987, the Dow Jones average declined by nearly 23%. That day marks the largest one day decline in stock market history. If you had been sitting on the sidelines, with your money in cash, during October 1929 and 1987, you would have avoided two of the worst months in the stock market’s history. Here’s the ten largest percent declines:

Rank

        Date     Close Net Change  % Change

1

10/19/87  1,738.74  −508.00

−22.61

2

10/28/29     260.64  −38.33 −12.82

3

12/18/1899       58.27  −7.94 −11.99
4 10/29/29     230.07  −30.57

−11.73

5 11/06/29     232.13  −25.55

−9.92

6

08/12/32       63.11  −5.79 −8.40
7 03/14/07       76.23  −6.89

−8.29

8

10/26/87  1,793.93  −156.83

−8.04

9

10/15/08  8,577.91  −733.08

−7.87

10 07/21/33       88.71  −7.55

−7.84

 

The Best of Times
If you elected to sit on the sidelines,  with your money in cash during those periods, you would have also missed out on several of the largest one day gains the Dow Jones Industrial Average has ever seen. Here are the ten largest percent gains:

Rank

        Date     Close Net Change  % Change

1

03/15/33       62.10              8.26 15.34
2 10/06/31       99.34            12.86

14.87

3

10/30/29     258.47            28.40 12.34
4 09/21/32       75.16              7.67

11.36

5

10/13/08  9,387.61          936.42 11.08

6

10/28/08

 9,065.12          889.35

10.88

7 10/21/87  2,027.85          186.84

10.15

8

08/03/32       58.22              5.06 9.52
9 02/11/32       78.60              6.80

9.47

10 11/14/29     217.28            18.59

9.36

Seven of the date worst one-day performances in the history of the Dow Jones Industrial Average took place during the “Summer” six months, between May and October. If you had been out of the market during those months, you would have avoided those huge market declines. However, seven of the best single day performances in the Dow took place during these Summer months as well. You really shouldn’t try to time the market. If you are a long term investor, you should probably just remain fully invested at all times.

During the past 46 years, from 1970 through 2015, the stock market averages declines 15 times. The average decline during those 15 years was 8.0%. That’s a sizable drop in value. However, during the other 30 years within this 45 year time frame, the market averages increased by an average of 5.6%. In two out of three years, over the past 45 years, the market has actually increased in value over the Summer months. Cumulatively, during the Summer months for all 46 years, the average return was slightly positive, showing a 1.0% average annual increase in value. That average includes two of the worst years in the stock market’s history: 1987 and the Great Recession in 2008-09. Even allowing for those trying years, the market averaged a slightly positive period for those Summer months. What will happen in 2016? No one has a crystal ball; it’s anyone’s guess.

Getting a bit frothy
On thing that is clear though, the market averages do feel a little frothy at this point. The S&P 500 average P/E  ratio today sits at an estimate 23.87. Historically, anything above 15 was considered high. In recent years, that assessment of what is high has been relaxed by many and 20 might now be considered an acceptable P/E ratio. Regardless, at nearly 24, the P/E ratio of the S&P 500 index is getting a bit high of late. (The following chart has been intentionally truncated a bit, chopping off those “off-the-charts” anomalies which took place in recent years.)

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As you can see in the chart, even if you consider a P/E of 20 as your limit, the market has recently been above that. But should this mean that it’s time to get out? Should you try to time the market? Timing the market is hard. Okay, timing the market is near impossible. If you think it’s high and it’s time to get out, how will you know when to get back in. Earlier this year, the market dropped by 11%. It has since rebounded. What if you had been fortunate enough to have sold before the decline. Would you know when to get back in? Would you have missed the climb back up?

Time is on my side
Here are three quote on market timing that I like:

From Warren Buffett:

“I never have the faintest idea what the stock market is going to do in the next six months, or the next year, or the next two.”

From Professor Eugene Fama:

“Do nothing. I think all of this market timing is statistically unfounded. I don’t trust it. You may avoid a downturn, but you may also miss the rise. Choose the risk tolerance you’re OK with and hold tight.”

From John Kenneth Galbraith, Economist:

“The only function of economic forecasting is to make astrology look respectful.”

Three well respect individuals who think you should ignore those market timers. If they think that you should avoid market timing, it’s probably not a bad idea.

One additional reason that you should probably not try to time the market is the capital gains issues. If you sell your holdings in order to try to avoid any market downturns, you will have to pay taxes on the gains you had. Hypothetically, if you were to “sell in May and go away” each year, you would have short-term capital gains taxes to pay. (Short term capital gains are taxed at a higher rate than long term capital gains.)

Short-term capital gains

Short-term capital gains do not benefit from any special tax rate – they are taxed at the same rate as your ordinary income. For 2015, ordinary tax rates range from 10 percent to 39.6 percent, depending on your total taxable income.

If you sell an asset you have held for one year or less, any profit you make is considered a short-term capital gain. The clock begins ticking from the day after you acquire the asset up to and including the day you sell it.

Long-term capital gains

If you can manage to hold your assets for longer than a year, you can benefit from a reduced tax rate on your profits. For 2015, the long-term capital gains tax rates are 0, 15, and 20 percent for most taxpayers. If your ordinary tax rate is already less than 15 percent, you could qualify for the zero percent long-term capital gains rate. For high-income taxpayers, the capital gains rate could save as much as 19.6 percent off the ordinary income rate.

In short (pardon the pun) don’t try to time the markets. Economists and the best minds in the investing world think that trying to time the market is futile. Don’t sell your investments in May and get back into the market in November. By trying that approach, while you might miss out on possible losses, you might also miss out on potential gains. One thing is certain, if you had gains on your holdings before selling,  you would have to pay capital gains taxes.

Stay the course
Simply stated, stay the course. Continue to save and invest your money throughout your career. Ideally you want to invest at least 15% of your gross wages; more if possible. Your money will compound and grow over time. Historically, the S&P 500 has returned 9.6% annually. If you simply invest your money in an S&P 500 index fund, it will compound and grow over time. If you invest $3,000 a year in the S&P 500 index fund for 40 years, you will likely have amassed a tidy $1.3 million. Of course, your returns will not consistently be 9.6%; some years you might lose money, but over the long haul, you will probably not find a better, more reasonable place to invest your money.

Invest your money regularly. Don’t try to time the market. In fact, don’t even pay attention to the stock market. In yesterday’s Berkshire Hathaway shareholders meeting, Warren Buffett supported the idea of investing your money and not paying attention to it at all.

Photo credit: Jeff Kubina 

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