You may already be familiar with the catchy bit of investment advice to "sell in May and go away."
Historically, the first day of May kicks off a seasonally weak period for stock prices that lasts through October.
That also means that most of the gains in the U.S. stock market come from the period between the start of November and the end of April.
This implies a shockingly simple strategy:
Invest in an index fund during November through April and then switch into money market funds until the next November, and you'll be much better off than an investor who stays fully invested throughout the year.
In fact, I'm surprised there isn't a “smart beta” exchange-traded fund (ETF) that puts this strategy into practice.
I'm guessing that's because the “sell in May and go away” strategy is just too “shockingly simple.”
'Sell in May and Go Away:’ A Remarkably Persistent Effect
Along with the “small-cap effect” -- the basis of my recent $25,000 bet against Warren Buffett -- the “sell in May and go away” market anomaly is one of the few that has stood the test of time.
A portfolio invested in the S&P 500 index starting with $10,000 in 1950 grew to $1,138,103 by May 5, 2012, simply by buying the index each year on Oct. 28 and selling the index on May 5.
In contrast, the same portfolio's value actually decreased to $6,602 when an investor with $10,000 purchased the index each year on May 6 and sold the index on Oct. 27.
Now, that's a strategy with a longer track record than Warren Buffett himself.
And according to my back of the envelope calculations, it also outperforms the S&P 500 by over 2% a year.
And recent market history is a terrific highlight reel of poor market performance in the summer months.
During the financial crisis of 2008, the S&P 500 lost 27.3% during the May through October period.
Two years later, the “Flash Crash” of May, 2010 wiped almost 1,000 points off of the Dow in a few minutes' time.
August 2011 saw a 20% correction in the S&P 500 that threatened to be a reprise of 2008.
No wonder many investors think it's a good idea to sit on the sidelines during this turbulent time of the year.
Still, it's hard to get your head around why this anomaly persists.
Finance academics who have studied the effect are similarly puzzled.
The best they could do was a study published in the December 2002 issue of the American Economic Review, which suggested that the effect is the result of most big investors and traders heading off on summer vacation in May. That also explains why trading volumes are generally lower during the summer vacation months than during the winter.
Putting ‘Sell in May and Go Away’ into Practice
Whatever the explanation, I must confess that I'm particularly partial to this market anomaly.
I think it's because I'm a big fan of the Pareto principle -- popularly known as the “80-20” Rule. That rule suggests that 80% of your results come from 20% of your efforts.
The “sell in May and go away” anomaly in markets seems to me to be an extreme case of this.
Alas, this market anomaly does not always hold. Just last year, for example, the S&P 500 rose 8.68% between May 5 and Oct. 27.
Nevertheless, if you want to play the odds -- and to enjoy the same six-month vacation large market players apparently do -- “sell in May and go away” might not be such a bad idea.
With that, here are a couple of caveats.
First, taxes on your gains during the “good six months” in a taxable account will quickly eat away your gains. So if you do implement this strategy, do it only with a non-taxable account.
Second, realize that your biggest enemy is yourself.
Knowing what is right to do is a lot different from actually doing on it.
The gist of any diet book ever written can be summed up in four words: “eat less and exercise.”
And yet, there are plenty of overweight folks around.
I bet it would take only two or three years of this strategy not working for you to abandon it.
Just look at how quickly investors dumped commodity stocks or emerging markets after a couple of years of lousy performance.
The bottom line?
Just because this strategy is “shockingly simple” doesn't mean it is easy to implement.
In case you missed it, I encourage you to read my Global Guru article from last week on Eagle Daily Investor about three picks that are beating the rest of the market. I also invite you to comment in the space provided below my column at Eagle Daily Investor.
NOTE: Global Guru Capital is a Securities and Exchange Commission-registered investment adviser, and is not affiliated with Eagle Financial Publications.
BIG ANNOUNCEMENT: On May 1, I'll inform you about a significant opportunity... one that could have a major impact on your portfolio, for years to come. Stay tuned.
Nicholas Vardy, CFA
Editor, The Global Guru
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