Summer Market Volatility Is a Myth: Don’t “Sell in May”

There’s an old adage that advises investors to “sell in May and go away.” It implies that you can avoid summertime stock market volatility by exiting equity positions in May and getting back in November on the faulty assumption that November to April is the best period for stock gains. By mid-April each year, you don’t have to look far to find a market pundit opining on television or in the financial press about whether or not this is the year to “sell in May.” The fact that this old notion still persists – despite decades of evidence that there isn’t a consistent pattern of market volatility in the summer months – probably stems from the irresistible urge investors have to try to time the market.

If you take a look at what would have happened to investors if they had employed this “conventional wisdom,” the results are startling. For a single investment of $1,000 in 1929, the repeated strategy of selling every May and reinvesting in November would have diminished the return the market delivered by a whopping $2,766,363. And that analysis takes into account only the market’s returns. If you also accounted for the taxes on short- and long-term capital gains that investors would have to pay every time they exited the market, the value of their investments would diminish much further. It may be boring, but the “buy and hold” approach to investing is generally the best way to go.

Of course, it’s not just investment adages that stir people to take action in ways that can be misguided. Major market upheavals – like the burst of the tech bubble in 2000 or the Global Financial Crisis of 2008 to 2009 – often cause a mass exodus from the stock market. But anyone who sold stocks after the Dow Jones Industrial Average reached its low of 6,600 in March of 2009 would have missed the market rally that quickly followed. Bad timing decisions undoubtedly explain why the market’s returns are generally far higher than the returns the average investor actually experiences. The return on the U.S. large-company index – the S&P 500 Index – for a 30-year stretch that extended through both of those crises, was 10% per year, but the typical investor earned only a fraction of that at 2.4% per year.

The problem with trying to time the market is that even for professional investors it’s difficult to predict what the market will do over the short term. For the average investor, it’s next to impossible. Fortunately, there are better ways to participate successfully in the long-term growth of the market. The key is to follow a few simple strategies:

1.      Put Your Money to Work

Some investors today are waiting on the sidelines, concerned the political environment seems turbulent or that stocks look expensive now. They think that, if they wait, the picture will become clearer or prices will fall. There are two problems with this approach. The first is that, in the present moment, the picture is never clear. There are always uncertainties. It’s worth noting that the overall volatility of the market was lower during the past 20 years  ?  a period that included the tech bubble and the financial crisis  ? than it had been during the previous 100 years.

The second reason to avoid waiting on the sidelines is that your money needs time to grow. That is why financial advisors routinely tell their clients to resist timing the market and instead focus on time IN the market. Time is a powerful builder of wealth because of the impact of compounding on returns. I’ve said it before in this space, but I think it bears repeating: Albert Einstein called compound interest the eighth wonder of the world. It can truly have a magical impact on the growth of your savings and investments. But compounding only works if you leave your money alone. And that’s the best part. While you may have to work hard to earn your money, time and compounding don’t need any further effort from you to make it grow.

2.      Make a Plan – and Stick with It

In a report issued last year, the Economic Policy Institute found that nearly half of all American families had no retirement savings. Even for those who did, the average amount that families had saved was woefully short of what people will need to live on for retirements that today can last 20 to 30 years.

While the prospect of saving for any expensive long-term goal, like funding retirement or college, can seem daunting, the first step to reaching that goal is always making a plan. If you don’t already have one, consider meeting with a financial advisor to start mapping out your plan. Talking to a trained professional will make what you need to do seem far less formidable. A sound plan will have a few basic components – like paying yourself first to make sure you’re setting aside the amount you need to save each month; allocating your holdings across a variety of asset classes, like stocks and bonds, to effectively diversify and manage risk; and sticking to your plan so that you can avoid the unfortunate consequences of overreacting to short-term market events.

If you have any concerns about the cost of working with a financial advisor, don’t be afraid to ask how much you’ll be charged for their services. Financial advisors are trained to provide clear and easy-to-understand explanations of the fees associated with their services and any investments they recommend. You’re likely to find the detailed investment plan a professional advisor can devise for you – and the calm, reassuring perspective they can offer when you’re tempted to react to any short-term market disruptions – will make the fees you pay for their service more than worthwhile.

3.      Have Patience

After disparaging one adage at the outset of this column, I’d like to close with praise for another one: Good things come to those who wait. When it comes to investing, patience can make all the difference in your long-term success. If you resist the urge to respond to whatever alarming news is blaring across the daily headlines, you’re more likely to avoid the fate of that “average investor” who earned only 2.4% per year when the market delivered 10%. By maintaining the discipline to leave your investments alone, and adding to them every month with whatever amounts you can afford, you can take advantage of another reality about the stock market: rallies often come in the aftermath of downturns and in quick, sudden bursts. Just consider that the 10 best days in the market over the past 20 years accounted for 50% of the returns it delivered through that period. The disciplined, patient investor is far more likely to be fully invested in the market on those critical days.

Go Away – and Make It Somewhere Fun

In the final analysis, maybe it’s just the “sell in May” part of that old adage that is misguided. “Go away” for the summer makes good sense. Enjoy the warm weather, focus your energies on planning a fun vacation, and don’t worry about what the daily headlines or the talking heads in the financial media are saying. Ignoring the short-term noise is probably the best way to reach your long-term goals.