Investing by stock market lore could be a money-losing strategy
“Sell in May, go away, and don’t come back ’til Labour Day” is one of those bits of market lore that’s trotted out from time to time. Other instances of such supposed deep wisdom include, “Never try to catch a falling knife,” and “Take your losses but let your profits run.” They certainly sound like some sort of meaningful prescription for guidance in the markets, but unfortunately they’re more like fairly tales, but without the moral lesson.
Seasonal patterns are not reliable
“Sell in May and go away” refers to a seasonal pattern that has sometimes been observed in the past – when markets tended to weaken over the summer months, rallying again in the fall when everyone’s finished with beaches and barbecues. But I do not recommend following this or any bit of market lore as a strategy for investing. Seasonal patterns are not really a reliable operating principle of markets. The problem is that sometimes they weaken, and sometimes they don’t. It is very difficult to time the market under any circumstances, because you need to get your exit and reentry points exactly right for this type of strategy to work. Relying on historical cyclic patterns that appear “sometimes” is a risky investment strategy.
Using the “sell in May” market lore, you’d sell your stocks in May or June and and switch into bonds. Then in the fall, you’d reverse the process and move back into stocks from bonds. Trouble is, if you fail to execute this strategy at just the right time, you could easily end up selling at a market low and buying back in at a market high – for either stocks or bonds. Not only do you incur extra trading costs, but you could severely cut overall performance in your longer-term retirement strategy.
In fact, if you had used this strategy just last year, you would have lost out on one of the fastest market rallies in recent memory. Canadian stock prices actually rose 9.5% from April 27 to Sept. 7, following a the pandemic-inspired market crash through February and March. Selling in May would have made your gains disappear. Or if you had decided to sell out at the bottom of the market in mid-March (a depressingly common occurrence with retail investors), you would have missed that initial 9.5% surge entirely.
Asset allocation, not market timing
Instead of using bits of market lore as a guide to investing, my advice is to hold a diversified portfolio based on the kind of strategic asset allocation model that I recommend.
Assets fall into three key groups: safety, income, and growth. The weight that each group commands in your portfolio largely determines the return you can expect and the risk that you’re accepting over a given time. If that allocation is skewed by extraordinary gains or losses in one class or another over the year, your risk profile will change. For example, if fixed-income has outperformed, the overall value of that asset class will have increased and may now be overweighted in your portfolio. But because fixed-income is considered more defensive than equity, that means your overall risk profile has become more defensive, perhaps more than you wish. Review your asset allocations annually to ensure your portfolio risk profile hasn’t drastically changed.
Make sure you have sufficient diversification in each main asset class. Diversification is at the heart risk mitigation. It doesn’t make a lot of sense to hold only one bond in your fixed-income class and only one stock in equity. Review your portfolio annually to ensure individual asset classes contain a sufficient number of diversified individual securities to provide good diversification. In fixed income, for example, you’d spread weightings among federal, provincial, and corporate bonds. And in equities, you’d diversify by sector, by region, by capitalization, and so on to achieve your desired risk level.
This kind of strategic approach will serve you much better over the long term, mitigating risk, and smoothing out episodes of cyclicality or seasonality, than trying to time your investing using some sort of stock market magic or folklore. Leave the fairy tales to the kids.
