Swedroe: Don’t Sell In May; Don’t Go Away

A clever rhyme about how to act does not a rigorous investment plan make.

One of the more persistent investment myths holds that a winning strategy is to sell stocks in May and wait to buy back into the market until November.

While it is true that stocks have provided greater returns from November through April than they have from May through October, the equity risk premium has still existed for those middle-of-the-year months since 1926. In other words, selling in May and then going away hasn’t been a good strategy.

In fact, from 1927 through 2013, the “sell in May” strategy underperformed the S&P 500 Index by more than 1.5 percentage points per year. And that’s even before considering any transaction costs, let alone the impact of taxes. Taxes matter here because you’d be converting what would otherwise be long-term capital gains into short-term capital gains, which are taxed at the same rate as ordinary income.

And how did the “sell in May and go away” strategy work in 2014? The total return to the S&P 500 Index for the period from May through October was 9.0 percent.

In case you’re wondering how the strategy has done in recent years, the table below shows the returns of the S&P 500 Index for the last six May-October periods, a time when Treasury bills provided almost no return at all.

Note that the average return for the six six-month periods was 6 percent, an annualized return of about 12 percent. That’s larger than the S&P 500 Index’s annualized return from 1927 through 2013 of 10.1 percent. And there was only one year in the last six where the strategy would have worked.

The most basic tenet of finance is that there’s a positive relationship between risk and expected return. To believe that stocks should produce lower returns than Treasury bills from May through October, you would have to suppose that stocks are less risky during those months—a plainly nonsensical argument.

Why this myth persists is one of the great mysteries of finance. My explanation can be found in this quotation from Abraham Lincoln: “You can fool all the people some of the time, and some of the people all of the time.”

Larry Swedroe is the director of research for the BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.