Should You Sell in May? Read This First

Around this time of year, pundits and commentators invariably trot out the recommendation to "sell in May and go away," on the basis that returns from May through September have historically been awful relative to those earned during the complementary months. There is no shortage of folk tales in investing, so in the spirit of a superb book I'm currently reading -- Expected Returns by Antti Ilmanen -- I thought I'd listen to the data instead. Before you liquidate your stock portfolio, I recommend you review my findings below.

We're off to the races!
First, a bit of market history: "Sell in May and go away" did not originate on Wall Street, but rather in the City, London's financial district. In fact, the full saying is "Sell in May and go away; come back on St. Leger's Day." The St. Leger Stakes is the oldest of England's five horseracing classics and is the last to be run.

As far as I know, the data that are most widely cited by investors and brokers regarding this phenomenon are that of Ned Davis Research (not so for academics -- the seminal paper in that realm is Bouman and Jacobsen's The Halloween Indicator (link opens PDF file).) The following table contains one of NDR's findings regarding the S&P 500 (INDEX: ^GSPC  ) :

 

Current Value of $1,000 Invested in the S&P 500 Beginning on April 30, 1950*

Sell in May, buy back in October** $75,539
Buy in May, sell in October $1,032

Source: Ned Davis Research. *At March 31, 2012, does not include dividends. **Money is invested in stocks from Sept. 30 through April 30 annually and is in cash (no yield) during all other periods.

The numbers certainly look impressive: Stocks' price appreciation occurred almost exclusively (on average) during the period October through April. By comparison, holding stocks from May through September appears to have barely preserved the nominal value of the initial investment over a 62-year period!

Hold on
I'm perfectly willing to believe that there is a seasonal component to stocks' price appreciation that is inconsistent with efficient markets, but these data aren't enough to judge the efficacy of a seasonal switching strategy. In that regard, NDR's methodology suffers from several shortcomings: For one, it assumes that when the money isn't invested in stocks, it earns no return whatsoever instead of being invested in Treasury bills. Furthermore, their data do not account for dividends, a critical component of stock returns. Finally, there is no benchmark data corresponding to a straightforward "buy and hold" strategy.

The numbers
In order to address these issues, I performed my own calculations, using data series from Ibbotson Associates (a unit of Morningstar) that begin in 1926. The following table contains the results of my analysis:

 

S&P 500: Annualized Return (including dividends)

April 30, 1926 to March 31, 2012

Sell in May, buy back in October 8.4%
Buy in May, sell in October 5.1%
Buy-and-hold 10.0%

Source: Ibbotson Associates, Standard & Poor's, Federal Reserve Bank of St. Louis, author's calculations.

And your winner is...
There are two key observations here:

The "sell in May" strategy soundly beat the converse strategy, with a margin of outperformance that exceeds 3 percentage points on an annualized basis.

However, "Sell in May" underperformed buy-and-hold; in fact, the outperformance of buy-and-hold is understated because the returns in the table assume no transaction costs and no tax impact. Investors selling in May incur taxes on short-term capital gains and higher transaction costs than their buy-and-hold counterpart.

About the same
If you're clinging to the notion that "sell in May" could yet be superior to buy-and-hold on a risk-adjusted basis, you should know that both strategies have identical Sharpe ratios of 0.12 (the Sharpe ratio measures the incremental return that an asset or strategy generates per unit of volatility). That's not surprising, given that depending on where you are in the calendar, "sell in May" is either equivalent to buy-and-hold or simply earning the risk-free rate.

I think it's quite likely there is a seasonal effect to stock price appreciation that is more than simply a spurious historical observation. However, that's far from enough justification for reducing (much less eliminating!) one's exposure to stocks as May rolls in. The primary consideration when deciding one's allocation to stocks should be valuation, not the date on the calendar.

Overvalued stocks
Right now, U.S. stocks look at least somewhat overvalued, based on the Shiller P/E, which uses a trailing 10-year average of real earnings. Furthermore, I think we can expect a change in volatility regime as the year unfolds, with the exceptional uncertainty linked to the European sovereign crisis simply biding its time to manifest itself. As such, an underweighting in U.S. stocks is prudent for those whose equity exposure is in index funds such as the SPDR S&P 500 ETF (NYSE: SPY  ) or the Vanguard S&P 500 ETF (NYSE: VOO  ) . Investors who buy individual stocks based on a bottom-up fundamental analysis, on the other hand, need not be concerned. If you're in the latter camp, I recommend you take a look at "The Stocks Only the Smartest Investors Are Buying."

Fool contributor Alex Dumortier holds no position in any company mentioned. Click here to see his holdings and a short bio. You can follow him on Twitter. The Motley Fool has sold shares of SPDR S&P 500 short. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 30, 2012, at 5:40 PM, JadedFoolalex wrote:

    I say let the fools (not us) sell their stocks. When the prices of some rock solid stocks come down, we buy more, thus increasing the value of our portfolios and watching the other guys scratch their heads wondering why the values of their portfolios can't keep up with ours!!!

  • Report this Comment On April 30, 2012, at 5:58 PM, EquityBull wrote:

    The key to selling in may is following Buffett "be greedy when others are fearful". An analysis that shows more aggressive buying during the may-september would offer superior returns. So while everyone is selling one should be taking their stock at cheap prices while they put it on sale all summer long. Keep your longs and just add!

  • Report this Comment On April 30, 2012, at 6:19 PM, Bsorge10 wrote:

    If you have long term gains and low commissions then booked your gains now if you are fully invested.

    I have sold off almost 20% of my stocks that I feel may be shaky with high prices. Another important factor is that 15% LT calial gains is going away this year. In fact their might be a run to the exits this fall in anticipation of this.

  • Report this Comment On April 30, 2012, at 6:20 PM, Bsorge10 wrote:

    Read above "15% LT capital gains...."

  • Report this Comment On April 30, 2012, at 6:22 PM, TooTall100 wrote:

    Don't forget the fact that if you buy in May and sell in October, you are in the market 5 months. If you do the other, you are in the market 7 months. That's a 40% increase in time and more than neutralizes Alex's (improved) findings.

  • Report this Comment On April 30, 2012, at 6:24 PM, TMFAleph1 wrote:

    "That's a 40% increase in time and more than neutralizes Alex's (improved) findings."

    What do you mean by "neutralizes" here -- can you expand?

  • Report this Comment On April 30, 2012, at 6:27 PM, budro2201 wrote:

    Alex, I am curious as to why you did not crunch the second set of numbers -- the ones that compared rates of return from 1926 to the present -- based upon the same time period as the first set that spanned 1950 to the present. Was that data not available from Ibottson? It seems like a closer apples-to-apples comparison would use the identical time frame, assuming the data is available.

  • Report this Comment On April 30, 2012, at 6:40 PM, TMFAleph1 wrote:

    @budro2201

    I did crunch those numbers, too, and had originally included them, but left them out of the final version for multiple reasons (space constraints, longer periods tend to be more representative, etc.)

    It would not be an apples-to-apples comparison anyway due to the differences in methodology that I describe in the article. In case you're interested, the results over the time period 04/30/1950 - Q1 2012 are:

    Sell in May, buy back in October: 11.3%

    Buy in May, sell in October: 4.3%

    Buy-and-hold 11.0%

  • Report this Comment On April 30, 2012, at 7:00 PM, thefreeb wrote:

    the "sell in May" strategy appears to be superior for the last 62 years - changes your conclusion considerably. Odd that you compared two different time frames in the original article. I think more recent time frames are more representative as long as they are long enough to average out short term peaks and valleys. The current market is a lot different from pre-WWII market - hedge funds, mutual funds, ETFs, bear raids and massive computerized trading have changed the game.

  • Report this Comment On April 30, 2012, at 7:04 PM, silverfox67 wrote:

    The market from 1994 to present is not the same as your father's market. The hedge funds- EFT's have created casino type trading. How does the calculation look if you compare the last 20 years?

  • Report this Comment On April 30, 2012, at 7:09 PM, silverfox67 wrote:

    Should be ETF's- exchange traded funds..

    Also- "puts and calls" started when?

  • Report this Comment On April 30, 2012, at 7:14 PM, TMFAleph1 wrote:

    @thefreeb

    The 30bps in outperformance for "sell in May" since 1950 would quickly melt away once you factor in transaction costs and taxes.

  • Report this Comment On April 30, 2012, at 7:26 PM, TMFAleph1 wrote:

    @silverfox67

    Today's market is different than your father's market -- but it's not easy to say how it is different with regard to impact on the comparison of two different strategies. In the absence of a much more detailed analysis, I don't think it's unreasonable to assume that the longest timeframe is the most representative in this case.

  • Report this Comment On April 30, 2012, at 8:07 PM, Hawmps wrote:

    How about count your dividends all summer long and go bargain hunting in October... October had one of the best days to buy all last year. Personally, I recently cashed out of a short term holding and took my gains in preparation for a little bargain hunting down the road. All it takes is for the sky to fall for a couple days and you have a buying opportunity.

  • Report this Comment On April 30, 2012, at 9:04 PM, luckyagain wrote:

    How many people were investors in 1926 or even 1950 and are around today? How does this strategy work for the last 10, 20 and 30 years?

  • Report this Comment On April 30, 2012, at 9:29 PM, TMFAleph1 wrote:

    You ask, I deliver:

    Strategy (1) (2) (3)

    04/30/2002-Q1 2012 7.8% (1.1%) 4.8%

    04/30/1992-Q1 2012 10.0% 1.7% 8.5%

    04/30/1982-Q1 2012 12.0% 4.1% 11.6%

    (1): Sell in May, buy back in October

    (2): Buy in May, sell in October

    (3): Buy-and-hold

  • Report this Comment On April 30, 2012, at 10:36 PM, Tsharp1947 wrote:

    Yawn!!!

  • Report this Comment On May 01, 2012, at 1:22 AM, TC118 wrote:

    I found it interesting that the original saying had nothing to do with any serious analysis. Here we see that for the little investor, the buy-and-hold strategy is superior. For example, on TD Ameritrade a $9.99 trade fee x 2 (one to sell in May and one to buy in October) represents almost 2% of a $1000 investment. Lower the invested amount to $500 and you are talking 4%. At this level the trading costs outweigh any incremental benefit of the sell and buy strategy by 10 times in the last 30 year period.

    I read several years ago somewhere on the Motley Fool site that you should not spend more than 2% on your trading costs, so I always stick to that rule (using a $1000 position) unless I am dealing with a higher risk stock where the volatility makes me uncomfortable with such a large position. Even at 2% the buy and hold is superior in the 20 and 30 year period.

    Add in the value of the opportunity cost of the time saved not having to execute the trades and research the new purchases and the equation becomes even more lopsided. Even just one hour of research at minimum wage would add another .85% and I am willing to wager that the average Fool makes considerably more that minimum wage.

    In any case, this article was eye opening. I think I will just sit back and enjoy my vacation in Colonial Williamsburg this May knowing that unless a Fool tells me to sell one of my stocks, I can happily hold on to them.

    Fool on!

    Tanya

  • Report this Comment On May 01, 2012, at 6:52 AM, skypilot2005 wrote:

    Timely, informative article.

    Thanks, for putting it together.

    Using the strategy referenced in this article has occurred to me this year.

    BTW: I’ve only tried to “Time The Market” once. My concern was the Macroeconomic conditions at the time. I used the level of the S&P 500 as the reference.

    I sold everything around 1400 before the 08’ “Crash”. I then started selectively, stock by stock,

    reentering the Market.

    I am over 90% invested, now.

    It worked out for me but, do not recommend it as an investment “Strategy”.

    Sky

  • Report this Comment On May 01, 2012, at 7:18 AM, skypilot2005 wrote:

    Alex,

    Have you ever looked at how the Market does historically during Presidential election years?

    I haven’t.

    Just a thought.

    It might be interesting.

    Sky

  • Report this Comment On May 01, 2012, at 7:44 AM, TMFOpie wrote:

    Tanya,

    Well said. We do suggest that you aim to keep your commissions below 2% so they don't eat into your stock performance, as so happens with so many traders. Now, fortunately, trading costs are so low these days, $5-$10 or so (some even free to buy), that most investors, even regular Joes like us, can meet that goal. So that's good. The difficulty is that studies show individual investors sometimes trade more than they should, and that can add up in trading costs over time. So it's good to monitor your trading activity, keep an investing log when you make a decision (why, how you're feeling, what's happening in the market, etc.) and make sure you don't act out of haste with any investment. I think over time, by investing in a diverse basket of companies, aiming for returns over 3-5 years and keeping a check on your trading, investors will do ok through the ups and downs of the market/economy.

    Fool on,

    Andy

  • Report this Comment On May 01, 2012, at 10:03 AM, RodgerKing wrote:

    I cannot understand how the sum could be greater than the two parts. Using the original numbers,

    Sell in May, buy back in October 8.4%

    Buy in May, sell in October 5.1%

    Buy-and-hold 10.0%

    In normal math, the buy and hold should be between the two other numbers. How is this possible that the sum is higher than the two parts?

  • Report this Comment On May 01, 2012, at 10:17 AM, TMFAleph1 wrote:

    @RodgerKing

    There are a number of reasons why the "buy-and-hold" return isn't equal to the sum of the return on the two seasonal strategies.

    Keep in mind, for example, that, in the seasonal strategies, the monies *are* earning a return when they aren't invested in stocks. The assumption is that anytime monies are out of the stocks, they're invested in Treasury bills.

  • Report this Comment On May 01, 2012, at 11:29 AM, lehem wrote:

    I don't like the idea of putting money in t-bills during the off season. You are adding another variable to your problem. Does the performance of tbills change on a similar timeline? If you are ignoring taxes and transaction fees I think the money should earn nothing in the off season so that people can see the performance differences clearly. If that was the case would the numbers add up? c=a+b.

  • Report this Comment On May 01, 2012, at 12:07 PM, Oldfool666 wrote:

    The 1926-2012 data may be accurate but still misleading, since it includes the Great Depression, when all the rules were off. The 1950 data are more likely to be representative of the present.

    WRT the "Buffett Rule" -- you need MONEY to buy with, so sell in the beginning of the slump period and buy later on, after prices have come down.

  • Report this Comment On May 01, 2012, at 12:27 PM, TMFAleph1 wrote:

    "The 1926-2012 data may be accurate but still misleading, since it includes the Great Depression, when all the rules were off."

    I'm not sure what you mean by "all the rules were off" -- there are very few "rules" in the stock market. It would be a very grave error to simply dismiss that period on that basis. Furthermore, the Great Depression affected all three strategies.

  • Report this Comment On May 01, 2012, at 1:35 PM, dsciola wrote:

    Alex,

    Informative and thought-provoking article, always enjoy challenges to so-called Conventional Wisdom.

    Nonetheless I have to agree with some of the others that with factors such as decimalization, high-frequency trading, internet discount brokers and, easy access to information, and everything else over the last few decades, things have changed since the roaring 20's.

    Your analysis of each respective return strategy over the past 10, 20, and 30 yrs demo's this, with "Sell in May and Buy back in October" beating BAH and the reverse strategy by an increasing margin over each 10 yr time frame.

    Could you provide a little more info on how you calculated the returns for each respective strategy? At the least on the surface these figures show the summer months may provide the best valuations for initiating a position.

    Dom

  • Report this Comment On May 01, 2012, at 5:19 PM, TMFAleph1 wrote:

    @Dom

    Thanks for your comment.

    In "Sell in May, buy back in October," our hypothetical investor earns the total return generated on stocks for the months October through April and is invested in T-bills at all other times.

    "Buy in May, sell in October" is the converse strategy.

    "Buy-and-hold" represents the total return on stocks over the observation period.

  • Report this Comment On May 01, 2012, at 7:09 PM, TMFAleph1 wrote:

    @lehem

    Including a return on cash is the most realistic assumption in comparing two systematic seasonal strategies.

  • Report this Comment On May 01, 2012, at 10:29 PM, snickerdoodle9 wrote:

    I am not parting with my high yield dividend holdings and blue chip /corporate bond holdings in May or anytime unless I see a drastic cut ( below 4% ) in the dividends . So far that hasn't happened . I love getting paid to own the companies that I hold . AGNC just paid out their dividend today . I reinvest the divvies with every payout .

  • Report this Comment On May 01, 2012, at 10:41 PM, TMFAleph1 wrote:

    @snickerdoodle9

    Unless you're a professional investor, I'd be extremely wary of holding AGNC. For more on this topic:

    http://www.fool.com/investing/general/2012/03/07/are-mortgag...

  • Report this Comment On May 01, 2012, at 11:50 PM, daveandrae wrote:

    Alex-

    You left out one, critical component in your analysis.

    Most people aren't even thinking about BUYING BACK once they have sold out of the market. This is especially true during times of high volatility such is commonly the case between September and October.

    Hell, the general public is still so shell shocked from the 2008-09 bear market, that I could not convince any, not some, not most, but ANY of my friends to buy back at the start of 2012 even when the s&p 500 yielded 8% in earnings power compared to 2% interest from ten year treasury bonds and 0% interest from cash.

    Why?

    "the market is rigged", "its too volatile", "too risky"...etcetera, etcetera, etcetera,

    If one were to juxtapose that which matters most, INVESTOR return, against "investment performance", even in times of a general rise in the market, the results would be horrifyingly diametrical.

    Thus, this post, while informative, is largely academic.

  • Report this Comment On May 02, 2012, at 9:42 AM, nickolassc wrote:

    1. You are ignoring which asset class to buy sell annually.

    2. Don't ignore alternative investments in midterm bonds for the sell season

    3. You have the sell season dates slightly wrong

    4. This strategy combines with another market timing strategy to work most effectively.

    5. I've already said too much. Buy and hold forever, ignore my insane ramblings.

  • Report this Comment On May 02, 2012, at 8:04 PM, trailsnorth wrote:

    Please, your insane ramblings are intriguing me. Would you care to share?

  • Report this Comment On May 04, 2012, at 2:12 PM, DutchMark wrote:

    How about selling in August and buy the end of December?

    All the major stock crashes happened in the fall...

    Timing the market is a fool's game.

  • Report this Comment On May 04, 2012, at 2:13 PM, win4ward wrote:

    If I understand correctly, all the number crunching was based on the S&P500, correct?

    If so, I think it would be illuminating to see the results of separate number crunching for large and mid cap stocks vs small cap stocks vs IPOs, maybe even separating large vs mid cap stocks.

    Is anyone interested in this comparison?

  • Report this Comment On May 04, 2012, at 4:05 PM, sagehen61 wrote:

    Election years, in the past, may not be much of a guide to the present. We have had serious recessions almost always within months or even a year after every Republican presidential victory, other than Eisenhower's, while the markets have done better with Democratic presidential victories. Those times, however, had a functioning Congress -- sometimes aligned with the president, sometimes not -- we do not have that luxury. Changes in the filibuster rules have made any majority less than 60% in the Senate meaningless. The House resembles something more like Shi'a vs. Sunni, or Spy vs. Spy than a deliberative body. Sky, we're on our own in this kind of variable!

  • Report this Comment On May 05, 2012, at 3:26 AM, TMFAleph1 wrote:

    @winward

    You're correct, yes.

    I could perhaps look at small-cap stocks in a new article.

  • Report this Comment On May 05, 2012, at 11:02 AM, XRAPTOR wrote:

    Hi folks,

    thanks for this analysis. I really love when people try to rip appart / test common knowledge for its validity.

    However I have some more questions:

    1.) Reading the Bouman and Jacobsen paper as far is I understand they took the MSCI dividend reinvested indices... so dividends are included

    2.) I am really shocked that T-bills make such a big difference.. ( c doesn t equal a+b..) and knowing that dividends are reinvestet, then the performance gap to buy and hold should even be larger.. and by the way: Bouman and Jacobsen assumed an investment in T-bills in the time in between...

    Did I get it totally wrong now? Because if dividends and T-Bills are also considered, yours and their analysis should have the same result...

    More comment: A german financial magazin just tetsted similar strategies and they had the best result when selling end of june and buying back beginning of October.. leaving out August and September.. actually for the last 23 years their "sell in summer" strategy yielded unbeliveable returns...

    Leo

  • Report this Comment On May 05, 2012, at 12:10 PM, 4melody wrote:

    Interesting article and following conversation.

    If you invest through a Sharebuilder account you can lessen the hit you take on buy and sell costs.

    Opening up an account and paying $20 a month allows you 12 buys a month. Additional buys are only $1. If you open up a ROTH account, reinvest your dividends and keep a buy and hold mentality, you should be able to reap some future tax-free funds after you have reached 59 & 1/2!

    You can sell within your account for $ 7.95 if you want to take some money off of one stock, EFT etc. to buy into something else within your portfolio.

    They do not charge to reinvest your dividends.

    You are always able to set up an account that is not a ROTH if you want the leeway of drawing funds out that will be taxed at normal rates.

    I've found it very easy to invest using smaller increments by maintaining both a ROTH and normal taxable account. By paying the $20 a month per account, they figure out your cost basis for you (updated daily) and make investing user friendly!

    So far as investments, timing etc. I personally look for Dividend ARISTOCRATS and think long-term!!

    The May - October connection just seems like a lot of extra fees, taxes and manipulation of the market!

    Invest on Fools!!

  • Report this Comment On May 05, 2012, at 12:32 PM, Paulson545 wrote:

    With Oil dropping isn't this a great time to buy a strong Refiner like Valero ?.....JMHO

  • Report this Comment On May 11, 2012, at 2:56 PM, barbarian312 wrote:

    Who the heck buys the whole S&P500? Isn't that why we're all Fools in the first place? We're trying to choose good investments not just blindly buy the whole market. Don't buy stocks that go down six months out of the year!

  • Report this Comment On June 08, 2012, at 8:35 AM, regemck wrote:

    This analysis was interesting. However, given the crash of 1929 wherein the market required more than 20 years to get back to pre-crash levels, it would have been far more valid to use Alex's analysis for the SAME time period as the other i.e. 1950 onward. Science and research and analysis segregate the kinds of info this article was seeking when fewer variables are changed. It would be great to see how the 1950 analysis holds up.

  • Report this Comment On March 12, 2013, at 9:12 AM, TMFAleph1 wrote:

    @regemck

    I presented those results in the comments above.

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