One of the longstanding idiosyncrasies of stock market investing is patterns. Human beings are keen on finding them, often where they don’t exist.
Scientists even have a word for it: “apophenia.” It means seeing connections and patterns that aren’t meaningful, and we all fall victim to it.
The crackpot version of our tendency to see patterns is the conspiracy theory. Odd lights flash in the sky and we imagine aliens are among us. People become transfixed by famous murders and ascribe motives to strangers in the background of random media images.
But we all do it, and especially stock market traders. Right about this time of the year you are likely to see headlines about how you should “Sell in May and Go Away.” This is a version of what’s also called the Halloween Indicator.
In short, some traders believe that we should get out of stocks entirely in May or, failing that, by June (thus the “June swoon” when hangers-on finally give up and sell). Then, it is supposed, we should all buy back in by October.
The point is to own stocks in winter and not in summer. The strategy’s proponents contend that the idea continues to work, while most economists and academics dismiss it as folk wisdom or pattern-seeking.
The funny thing is, the more people think it’s there, the more likely it is to be there for real. Fearing that they might miss a chance to market-time profitably (for once), the Halloween Indicator can become a self-fulfilling prophecy.
Naturally, selling all of your stocks and going to cash is very costly, and not just because of commissions. In fact, you are likely to miss a lot of months of appreciation and dividend income, money that could and should be growing your portfolio through compounding.
Likewise, if you hold stocks all through the winter, you are just as likely to see a downturn that will test your belief in any kind of market timing theory and could lead you to panic and sell for no good reason at all.
A far better approach is to own a portfolio of stocks, bonds, real estate, foreign stocks and bonds and commodities and to rebalance them. That way, you only sell when there is a good reason and you buy with good reason, too.
You can keep your costs minimized by using inexpensive exchange-traded funds instead of specific stocks or bonds, and the results are incontestable. Burton Malkiel, the author of the investment classic A Random Walk Down Wall Street, maintains that just rebalancing stocks and bonds over the past 15 years earned a 1.5% premium over the straight stock market.
That’s real money and a real return that could be had year-in and year-out and absolutely won’t be made by the folks sitting on uninvested cash all summer every year.
If you think you have a stomach for watching stocks rise in the summer while you are out of the market and then fall in the winter while you are in and you can afford that kind of emotional risk every single year, then “sell in May” might be for you.
But the surer path to retirement is buying your investments once and then rebalancing as need be, no timing necessary.