At about this time every year, the stock market adage “sell in May and go away” returns to haunt us, counselling investors to get out of the market while the weather is fine and there’s fun to be had elsewhere. They should not return until St Leger Day in mid-September, the ditty continues, thereby ensuring a satisfying rhyme to round off this hoary piece of financial advice.
Numerous researchers have examined the validity of the statement but as far as I’m aware have yet to demonstrate its worth as an investment strategy. This is not surprising—if it were that easy to know when to buy and sell, every fund manager would be doing it, particularly if they could guarantee themselves a whole summer off. In fact, if it were that easy we wouldn’t need fund managers at all and they could take the rest of the year off too.
The idea that it is possible to know when to buy and sell—“timing the market”—is appealing but mistaken. Getting one’s timing right is a matter of luck; sometimes you win, often you don’t. Having developed a strong like or dislike for an investment, we are usually tempted to buy or sell in one go, gaining immediate gratification of our desire to own it or be rid of it. Almost everyone struggles to remain for long in the limbo between having decided to buy or sell and actually doing so, which is why we end up falling victim so often to market timing.
In some cases, the rush may be justified, especially if there’s another pressing need for the money that will be released, for example. But in most cases, it’s better to move gradually, even though it is very hard in practice, so strong is our desire to turn decisions rapidly into action and move on.
But the process becomes even more psychologically testing than that, because the point of buying and selling gradually is to play the averages. This spreads your purchases or sales across a series of deals, meaning that the price you end up with is the average of your multiple transactions. Ideally, therefore, you want to make a series of buys when the price is falling, so that the average price you pay falls with each subsequent purchase. Similarly, you should sell when the price is rising so that the average price you realise goes up with every sale.
This approach makes sense in theory, but it’s incredibly hard to stick to—no one likes to buy a share and see its price fall, and no one enjoys seeing the price go up after they’ve sold. And anyway, markets rarely co-operate with our careful strategies and continue rising or falling to accommodate our plans. The only solutions are super-human patience and nerves of steel.
For those who lack these qualities, the best answer is to invest a fixed amount at regular intervals, thereby ensuring you buy more when prices are low and less when they are more expensive. This has the same overall effect and—best of all—can be automated so you do not have to waste your time watching prices in May or any other month of the year.