“We have long felt that the value of stock forecasters is to make fortune tellers look good." -- Warren Buffett
At its core, investing is about finding the balance between risk and reward that achieves your goals. Managing risk is an important part of successful investing, yet it can be difficult to distinguish effective risk management. A question that many investors face is when to invest – are there certain calendar months that are advantageous and others that should be avoided?
Debunking the January Effect
One of the more widespread beliefs is in the “January Effect.” This is the idea that stocks tend to underperform long term averages in December and outperform in January. The thinking is that many investors sell stocks in December to harvest capital losses that can be used to offset tax liabilities. Then, year-end bonuses are invested in January along with the proceeds of the December sales.
This theory first surfaced in 1942 and some early studies seemed to indicate it had merit, but modern statistical analysis has discredited this concept. A recent study of stock market returns since 1950 underscored these flaws by showing that calendar month returns in December average nearly double the returns in January (1.54% vs. 0.79%).
Sell in May and Go Away
The adage to “sell in May and go away” is a popular topic for finance journalists each year. This strategy dictates that investors sell portfolio holdings at the beginning of May and then stay out of the market before they buy back in at the beginning of November.
The basis of this strategy is to avoid holding stocks May through October, because the returns during this period tend to be lower than the rest of the year. Yet, like other strategies that attempt to time the market with seasonality, this has been debunked by investment professionals and academics.
An analysis of returns that include dividends between 1926-2012 shows that the “sell in May” strategy has been shown to underperform a buy and hold strategy by 1.6% annually. In fact, this strategy would underperform by a much larger margin once other finanical planning considerations like taxes and transaction costs are taken into account. Adhering to the “sell in May” strategy would require paying short term capital gains taxes every year that returns were positive, while a buy and hold investor would be taxed at a lower long term capital gains rate.
The Fallacy of the Crystal Ball
The common thread running through many of these seasonal strategies is the notion that a simple metric can predict stock market returns like a fortuneteller’s crystal ball. Countless academic studies have proven market timing to be counterproductive, despite the popular misconception that market declines can be sidestepped.
The reality is that investors with diversified portfolios and proper asset allocation strategies will achieve solid long term returns by maintaining exposure to stocks through market downturns. Time in the market, not timing the market, is what matters most. Accordingly, the best month to buy stocks is the first month that you can commit funds to a long term investment strategy.
A CFP® professional can help you design an investment strategy and stick to it, so that you avoid the fallacies the market may throw your way.