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Why the "Sell in May" Strategy Is Bogus

It's an old investment legend like the January Effect and the Santa Claus Rally. The theory is that you should sell stocks at the beginning of May and then buy them back at the end of October. Follow this strategy, so the legend goes, and you'll reap profits beyond what the average buy-and-hold investor will receive. Just like most other investment legends, this is one that's much more myth than fact, and seems to be impossible to kill off.

To test this theory, we created two portfolios. One buys the S&P 500 Index on Jan. 1, 1926 and holds that position. The other buys the S&P 500 on January 1, 1926, and holds that position through April 30, 1926. On May 1, we swap the S&P 500 with 30-day U.S. Treasury bills and remain in T-bills until Nov. 1. Then, we trade back into the S&P 500. This process is repeated every May and November, ultimately ending with data from April 2010.

The results tell the story -- if you had followed this strategy, you would have been worse off than if you just held stocks. The "Sell in May and Go Away" portfolio produced an annualized return of 8.18 percent. However, compare this to the return of the S&P 500, which produced an annualized return of 9.86 percent. The seasonal strategy described above performed nearly two percentage points worse per year since 1926.

So why does this myth persist? It's true that stocks have performed better from November through April than they have from May through October. Since 1926, the average monthly return for May, June, July, August, September and October was 0.74 percent, while the average monthly return for November, December, January, February, March and April was 1.14 percent.

However, there was still an equity premium during this time period. As mentioned above, the average monthly return to stocks for the months May through October was 0.74 percent. From January 1926 through April 2010, the average monthly return for 30-day U.S. Treasury bills was 0.30 percent. If you follow this strategy, you have to put your money somewhere safe (such as T-bills) when you get out of stocks. However, since stocks still outperformed Treasury bills even in the "worse-performing" months, an investor would ultimately lose out by following this strategy.

The moral of this story is that you should check both the academic literature and the historical evidence before implementing any investment strategy, even one that has become accepted as "conventional wisdom." In this case, we learned that while we can easily observe that certain time periods produce better investment returns than others, that doesn't mean it's something you can profit from.

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