Sell in May and Go Away?

It's that time of year again. As you turn the page on your calendar, you'll read stories telling you that it's time for you to sell all your stocks. Dump the entire portfolio, take a vacation, and forget about the stock market. You'll be glad you did.

While many people look forward to spring for warmer weather, leaves budding on trees, flowers poking through the last bits of snowy ground, and the opportunity to get outdoors and dispel the last remnants of cabin fever, investors instead get to listen to the annual call to play it safe.

Sometimes you win ...
Of course, with any seasonal indicator like this, you can always look to history and see how following an old adage would have worked out. Last year, for instance, some of my fellow Fools pointed out that as of September, you would've been better off if you'd followed the May-sale advice. Yet by November, that was no longer true, as the market went on a big run throughout the fall, led by companies like China Life (NYSE: LFC  ) and First Marblehead (NYSE: FMD  ) . Another article talked about the potential for taking advantage of the April effect that arguably results from people trying to jump the gun on selling in May. That said, studies that go further back see many signs that such a phenomenon exists. Backtests performed by members of the Fool Community's Mechanical Investing discussion board a couple years back gave some interesting insights, suggesting that different sectors of the market respond differently to the strategy.

The biggest problem with trying to time the market is that deciding when to sell is only half the battle. You also have to know when to buy back in. The nice thing about the Sell in May adage is that it tells you when to come back: early November, once the historical crash-prone period of September and October is over.

... but what about this time?
Even with history on your side, it's always easy to second-guess whether or not a seasonal strategy will keep working in the future. One news service has all its bases covered, with a story on why selling in May is the right thing to do, along with a feature on why 2007 may be different when it comes to the sell-in-May strategy.

Now you can even take the strategy up a notch. Using special inverse ETFs -- such as the UltraShort QQQ ETF (AMEX: QID  ) or the ProShares Short Dow 30 (AMEX: DOG  ) -- can make you money when markets fall. If stocks decline during the next six months, then you could end up with a bigger gain using an inverse ETF than by simply holding cash. But without that price drop, you could have been better off just putting your money in a money market fund or high-yield savings account.

The price to play
Seasonal strategies have costs that a simple buy-and-hold technique doesn't. Unless you're trading inside a tax-deferred account like an IRA or 401(k), all those purchases and sales every six months means that you'll regularly trigger capital gains tax liability. With only a six-month holding period, you'll pay top rates on those gains, as you won't qualify for long-term treatment.

In addition, you may have to pay extra commissions in order to get in and out of your stocks twice a year. Depending on the size and makeup of your portfolio, the extra expenses can put a big dent in your returns.

At the Fool, we tend to look at rules as things to be broken. For instance, even if selling in May is smarter than just holding stocks throughout the year, there might be even better rules to follow that require additional precision and work, as the folks on the Mechanical Investing board struggle to discover every day. On the other hand, others believe that stocks always offer opportunities for investors -- the secret is to find which companies will perform well in different market environments.

Regardless of what decision you make with your portfolio, have a happy May Day!

First Marblehead is aMotley Fool Hidden Gems recommendation. Want to know about more small companies poised for big returns? Take a 30-day free trial of the newsletter.

Fool contributor Dan Caplinger hasn't sold all his stocks today. He doesn't own shares of the companies mentioned in this article. The Fool's disclosure policy isn't seasonal.


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