By: Dividend Sensei
You Can Trade Sell In May…But Probably Shouldn’t
From 1990 through 2015 Fidelity modeled five hypothetical portfolios over the May through October time period. These ranged from 100% invested in the market (buy and hold), to a series of 50/50 mixes between and index fund and short-term treasuries (cash equivalent), bonds, or low volatility stocks such as those in defensive sectors. Note that this means investors would sell half their market position to rotate into other lower volatility assets or sectors, then rotate back at the end of October.
The results over this 25 year period showed that buying and holding the market the entire year resulted in 10% annual total returns but had the highest volatility (standard deviation). This is what one would expect. Interestingly enough various trading strategies did manage to beat the market including a 50/50 mix of bonds and stocks which achieved 10% outperformance with 6% less volatility. The best performance of all was from a rotation of half your money into a 50/50 mix of a consumer staple ETF and a healthcare sector ETF. This beat the buy and hold strategy by 30%.
So does this show that the road to riches in market timing the May to October time period? Actually no. Because while this study certainly has intriguing findings keep in mind that it doesn’t take into account taxes. The biggest downside of short-term trading is that if you own a stock (or ETF) for less than a year you will face short-term capital gains taxes. That means rather than pay 0% to 20% long-term rates (most Americans pay 15%) you pay your top marginal tax rate which can be as high as 37% under the current tax code. Most Americans (earning $38,701 and $157,500) would pay 22% to 24% on these gains.
|Strategy||Post Tax (Average American) Total Return||Post Tax (Top Income Bracket) Total Return|
|Buy & Hold S&P 500||10%||10%|
|S&P 500/Low Volatility ETF||9.8%||8.8%|
|S&P 500/ (Consumer Staples/Healthcare)||10.6%||9.5%|
When we adjust for the effects of selling half of your portfolio every 6 months we find that only the rotation into a 50% mix of consumer staples and healthcare ETFs is worth doing at all and that’s assuming you’re in the two most common tax brackets. If you’re in the top bracket than short-term capital gains taxes will make any sector/asset rotation strategy less profitable than just buying and holding. But the important thing to note is that each of these strategies, including the optimal one, still had investors 100% exposed to the market. In other words those who completely abandoned the market during these months? Well they missed out entirely.
Bottom Line: Time In The Market Will Make You Rich, Timing The Market Will Make You Poor
The most important thing to remember is that investing in the market means taking a stake in real companies, who operate year round to compound investor wealth over time. They don’t shut down from May through October and trying to time the market via such rules of thumb as “sell in May” is precisely why the average investor has so badly underperformed not just the market over time, but all asset classes.
Remember that any money invested in the market is there to compound over time, which requires maximizing your time in the market. Which is why avoiding such frivolous market myths as “sell in May and walk away” is essential to achieving your long-term financial goals.