Topic: Daily Advice

Investor Toolkit: The trouble with “selling in May and going away”

April 30, 2014|by Pat McKeough

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Every Wednesday, we publish our “Investor Toolkit” series on TSI Network. Whether you’re a new or experienced investor, these weekly updates are designed to give you advice on stock market trading and other investment topics that will help you develop a successful approach to investing. Each Investor Toolkit update gives you a fundamental tip and shows you how you can put it into practice right away.

Today’s tip: “The saying ‘Sell in May and go away’ is based on an approach to the stock market that works only sporadically and could actually cost you money if you go along with it.”

When investors base buy and sell decisions on short-term market forecasts, they often experience notably poor investment results, or even lose money. This may come as a shock to them. In hindsight, it may seem that past market trends, up or down, should have been easy to foresee. But in fact, nobody consistently foresees these trends. That’s why most investors hurt their returns if they let short-term market forecasts have much impact on their investment decisions.

This year, investors may feel tempted to follow the long-time saying that you should, “Sell in May and go away.” This saying is based on the observation that, over the years, stock prices have often gone sideways or dropped between May and October. This year, some investors feel the sell-in-May rule is timely. The market has been on a long upward trend, so investors may see it as due for a setback.

The problem with this kind of analysis is that it fails to distinguish between causation and correlation. The pattern of falling stock prices between May and October may simply be a coincidence, like the pattern that may appear in a series of coin tosses or spins of a roulette wheel.

Many investors have guessed right about a coming trend at one time or another. Maybe they bought just prior to a big upswing, or sold in advance of a major stump. In the long run, however, these experiences may wind up costing them money. They may bet twice as heavily on the next trend they foresee, with more volatile stocks, only to discover their forecast was 100% wrong.

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“Why would anybody work?”

Studies by the Dalbar organization show that if investors do a lot of in-and-out trading, they routinely make only about one-third of the return they could have earned with a simple buy-and-hold approach.

Studies of top performing mutual funds show most of their investors lose money or make negligible returns. That’s because most investors in a top performing fund only buy into the fund after it has already made big gains. Investors also tend to sell former top performing funds only after a major slump in the value of their holdings. When you chase investment performance, it’s all too easy to buy at the top and sell at the bottom.

Here’s an investor saying you should always keep in mind: “If it was easy to predict which way the market will go, why would anybody work?” In fact, it’s hard if not impossible to consistently profit from short-term trading. That’s due to the large random element in short-term market trends.

Sticking with a strategy that works

That’s why we advise you to stick with our three-pronged investment strategy.

1. Invest mainly in well-established companies, with a history of sales and earnings, if not dividends.

These are the companies that are more likely to continue to prosper in good times, survive market and economic downturns, and prosper all the more when conditions improve.

2. Spread your money out across the five main economic sectors: Manufacturing and Industry, Resources & Commodities, Consumer, Finance and Utilities.

All too often, investors diversify by investing in a number of companies that have overlapping weaknesses. These companies may all suffer due to a single negative factor.

By spreading your money out across the five sectors, you achieve much better diversification of your risks. You also increase your chances of stumbling across a handful of super stocks in the course of your investing career. These top performers may emerge from surprisingly modest circumstances.

Remember, you need a few top performers in your investing career, to offset the inevitable disappointments.

3. Downplay or avoid stocks in the broker/media limelight.

When stocks get too much favourable attention from brokers and the media, investors tend to develop bloated expectations for them, or bid up their prices. When media/broker favourites fail to live up to expectations, downturns can be sudden and brutal.

You’ll sleep better and make more money if you own a diversified portfolio of well-established companies, even if you rarely hear about them from the media or your broker.

COMMENTS PLEASE—Share your investment knowledge and opinions with fellow TSINetwork.ca members

Do you ever link your decisions on buying or selling stocks to specific times of the year? What is your reason for doing so? Have you changed your seasonal approach to investing over the years? Have you found any drawbacks to pursuing a seasonal approach to buying or selling?