“Sell in May” is both right and very, very wrong…

by Adam English, Outsider Club

At the risk of making this an annual occurrence, I’m going to wade into one of Wall Street’s most persistent tropes and stomp all over it.

About a year ago, we took a look at the “sell in May” concept, and I’m comfortable saying that I did pretty well in hindsight.

Last year I suggested staying in the market and focusing on two sectors via ETFs — the SPDR Health Care Select Sector ETF (NYSEARCA: XLV) and the SPDR Consumer Staples Select Sector ETF (NYSEARCA: XLP).

Between the beginning of May and the end of October, consumer staples were a bit of a let down at 6.67% compared to the sizable 8.3% surge in the broader market, but XLV crushed it with 17% gains.

The one thing I found truly disappointing was that I didn’t discuss how I feel about the trend as well as I think I should have, or cite exactly how you should use the “sell in May” trend in a real portfolio.

Let’s not waste time, and get right to everything that is right and wrong about “sell in May,” along with how it can be used to your advantage.

The Misleading Charts

First up, let’s get the idea behind this out of the way:

  • The idea is to sell at the beginning of May and buy back in at the beginning of November.
  • Over a 50-year timespan, May through October averages a -0.1% loss.
  • Over the same timespan, November through April averages a 7.5% gain.

So there we have it. This information — on its own — indicates we should sell. Why take a small loss while staying exposed to equity risk?

Now let’s take a look at the kind of chart that gets circulated around this time of year.

Here is a look at how a single dollar would grow if it were invested in just one of the six-month blocks each year:

sell in may chart

Notice the issue here? That one-dollar investment still turned into four dollars. That -0.1% average return did not properly express how, in reality, retaining equity exposure over the summer has not been bad. It just hasn’t driven returns well.

Then there is the whole issue of what you’re doing with your money while it is out of equities. Money markets, bonds, cash?

All incur their own risks without offering much at all (if anything after inflation) in the way of returns.

What if your otherwise long-term equity positions are dinged with massive short-term capital gains taxes every year?

The removal of wealth via taxation will be crippling to long-term wealth through compound growth. This will single-handedly turn the whole “sell in May” trend into a disaster for retail investors.

These unmentioned issues — and these are just a couple — make all the “chart of the day” posts this time of the year beyond useless.

It makes them dangerously misleading and potentially costly to investors.

The Timing Issue

Then, of course, there is the eternal problem of timing. Selling based off of an arbitrary date instead of capturing gains, cutting losses, re-balancing portfolios, or reevaluating risk is ill-advised.

Check out this chart from last year:

may to oct 2014

If you ignored the rule and stayed in the market, you’d have been exposed to 8.3% of gains in the S&P 500, unlike those that sold in May and bought in November.

If you bent the rule a bit and sold at the beginning of March and bought back on mid-October, you would have racked up a 8.35% gain, but incurred a tax burden.

If you followed the rule up until early October and were shaken by the steep drop, you’d have seen a loss and missed that two-week run.

While this was happening in real-time, absolutely no one knew what was going to happen and everyone acted differently.

The point is, hindsight — which is the entire basis of the “sell in May” trope — is completely worthless in the markets.

People are notoriously terrible at trying to time broad market moves, and letting short-term influences on broad market movements trump long-term considerations for index-based baskets, ETFs, or mutual funds is almost always damaging.

How to Do It Right

So on one hand, we have a trend that is absolutely real. Yet, the very name of it suggests an action that is all-but-guaranteed to hurt your wealth if you attempt to follow the trend.

So, how do we do it right?

The first step is to purge any ideas of any grand changes to your retirement accounts or allocations.

Yes, the trend exists, but it is far from absolute. Plus, it isn’t that equity exposure during these months is a bad thing. We just need to temper our expectations for large returns driven by growth and market inflows.

The next step is to start looking at ways you can slightly alter your investment behavior starting in or around May to gain a bit more exposure to what will pull in returns while equity growth tends to be stagnant.

For example, your regular contributions to retirement accounts can be put towards other investments during this period.

Then, from November through April, contributions can go towards balancing out your account to your ideal allocations.

No selling is needed, just an emphasis on returns, while staying consistent with your risk appetite and portfolio overall.

Anything from establishing positions that will provide unprecedented growth potential in the short-to-mid-term, to investing in companies that will return a high percentage of income through dividends, can work quite well.

With a bit of discipline and due diligence, you can boost your portfolio performance a bit each year, and reap massive rewards as relatively small gains compound into much larger account balances down the road.

Take “sell in May” for what it is, and please don’t ever think a sound investing strategy is so simple that it can be summed up in three words.

Take Care,

Adam English

Adam English

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