What's the basis behind this idea?
Sometimes. Supposedly the strategy is to sell in May and re-enter the market after the "worst" month in the year - which has historically been October.
Last year, getting out in May and re-entering in November would have been a fabulous strategy. You would have avoided the painful markets that began in July and didn't end until about November. It would have worked like a charm.
In 2010, however, the strategy would have worked against you, because the year's only market drop actually occured a month early - about April. Selling in May and re-entering the market in November would have caused you to miss out on a 15% rise in the market.
In 2009, the strategy would have worked even worse- you would have missed out on a 20% gain in the market.
So... if you know for sure what the market is going to do - AND if the market is going to drop in the summer and recover only after October - then yes, it is a great strategy.
But, if you are HUMAN like the rest of us... and can't see the future with absolute precision... then continuous investing in a portfolio designed to YOUR specific risk tolerance is the best way to build wealth. And if you have already built your nest egg - then keeping your portfolio built to your risk tolerance, and using tax-efficient withdrawal strategies is probably your best bet.
Market timing strategies and rules of thumb rarely work consistently. They work just enough to be attractive to market newbies - but they are wrong often enough to undo the profits they make when they are right. Additionally - selling in May or similar high-turnover strategies performed in a taxable (non-IRA) account add the additional pain of short-term capital gains taxes into the mix, further reducing your chance of actually accomplishing anything in your account but a bunch of non-profitable activity.
I think it's the media: Financial entertainment television shows, magazines, newsletters, etc. What they're talking about is market timing, a concept that numerous academic studies have discredited, at least when it comes to reaching your long-term goals. Just as with most things you see on tv, real life is often far different, and usually less exciting. And, successful long-term investing will more likely be tied to a responsible plan.
A better approach is not to try to `time' or beat the markets; but to use what we know about the markets to mitigate risk. Good luck!
What is clear Wesely, is that there can be a cost to market timing. According to Morningstar, an investor in large capitalizion stocks, like the S&P 500 or the Russell 1000, from 1992 to 2001(5,042 days) would have made a near 9% return. If that investor missed the 10 best days the return would have been about 4%. To carry the exaple further, if the investor would have missed the 20 best days, 30 best days, 40 best days, or 50 best days, the investor's return would have been 1.7%, -0.4%, -2.3%, -4.0%.*
Many of the missed days could have been during the period in question. This is a very good argument for staying fully invested, depending on your overall investment horizon.
There are all sorts of market observations that are usually true, until they are not.
*Source Morningstar 2012 Andex Chart.
Sell in May was based on seasonality.
There is validity to a seasonality approach, but after-tax benefit and costs can be a burden.
In general like, most strategies, it's not consistent so you may have long periods of underperformance before it works for you. Here's a great piece from my friends at Business Insider about the Sell in May theme in an election year. Depending on your core strategy and portfolio, this might be a valid addition as long as you consider the pros and cons. But it does have risk, of course. I'd suggest you find a good advisor to discuss it with you. ;)
Hi Wesley I totally agree with the answers on avoiding market timing. There are really three simple rules to investing for the long term. Own equities....globally diversify....rebalance. Try to work with an advisor who shares your philosphy, because your biggest enemy will be your emotions. Good luck.
It does seem there is some truth to this adage, though no one knows why, and it's probably a statitical fluke.
There are good reasons not to get too carried away with this idea, however, apart from the sensible things mentioned above.
Selling-in-May-and-going-away precludes compounding dividends, as someone employing this strategry would probably miss out on 2 payments a year. Given that 40% of the stock market's return over time is from compounding dividends, that is significant.