Stocks rebounded sharply on Friday, as investors chose to see declines from earlier in the week as an opportunity to pick up shares at bargain prices. As of 11 a.m. EDT, the Dow Jones Industrials (DJINDICES:^DJI) were up more than 117 points, and the S&P 500 (SNPINDEX:^GSPC) regained about half its lost ground from yesterday's 1% decline.
The move comes just as the annual calls to "Sell in May" come out in full force. With the seasonal strategy encouraging investors to get out of stocks for six months before returning in November, today's gains suggest most investors aren't heeding that advice. Yet when you look at recent results from following the Sell in May strategy, the move seems much more compelling, raising the question of whether you should use this market-timing method.
Does Sell in May work?
Investors like simple investing strategies, and they love simple strategies that work. Over the past year, the Sell in May strategy has performed tepidly. Between last November and yesterday, the Dow rose about 3%, following the average's roughly 5% between April and October 2014. Those figures reverse similarly close returns for the strategy in the previous year, when the Dow gained 7% in the winter half of the 2013-2014 period after rising 5% during the summer half.
Those two years follow a period during which selling in May paid off much more handsomely. Between mid-2012 and mid-2013, for instance, selling in May would have avoided a decline and given you full exposure to double-digit percentage gains during the subsequent six months.
Over the long haul, the strategy hasn't always worked, but it has a solid track record in terms of average returns. Much of the strategy's success comes from the fact that most of the steepest drops in the stock market have occurred in the autumn months of September and October, including the Crash of 1929 that led into the Great Depression, the 1987 market crash, and the worst parts of the 2008 financial crisis.
Why selling a bit in May might make sense
Some investors use the Sell in May strategy aggressively, getting out of all of their stocks and going to cash for the entire six-month period. Not only does that force you to rely on historical trends playing out, it incurs huge trading costs and harsh tax treatment on gains that can take away much of your profit.
Yet for those who have enjoyed the stock market's rise since 2009, looking at May as an opportunity to trim your holdings could make sense. Many investors never rebalance their portfolios to reflect changing market conditions; as a result, the rise in the stock market could have left you with a more aggressive investment stance than you thought. Selling some of your stocks to get your asset allocation back into balance is a smart way to hang on to hard-won gains and take advantage of bargains in other areas of the financial markets.
Selling in May for its own sake isn't a good reason to pull the trigger on a massive sale of your investments. As a trigger to consider rebalancing your portfolio, though, the strategy has some merit, especially with stocks remaining near all-time record highs.