Why 'sell in May' will lead you astray

Why following the accepted wisdom might be bad for your wealth

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Every year in May, an annual ritual in the stock market begins. Perhaps you've already heard all about how your best move is to dump every stock you own, head for the hills, and ride out an inevitable downturn between now and November.  Even though this thinking can be particular to the Northern Hemisphere, our market does tend to follow theirs, so looking to the US can be instructive in learning lessons.

I'm not going to tell you that I'm 100% positive that the market will go up over the next six months, debunking the "Sell in May" theory. But later in this article, I'll explain why most investors shouldn't even think about selling out solely because you changed your calendar. First, though, let's take a look at why the "Sell in May" theory is so popular.

Simple and effective

Everyone likes a simple way to get rich fast. The appeal of an easy-to-follow seasonal investing strategy is that you don't have to think too much. When May rolls around, sell. When November comes, buy everything back. What could be easier?

But an even bigger reason why "Sell in May" has gotten so popular lately is because it's worked — at least if you don't look back too far. Looking at the past two years:

Last year, selling in May was almost perfect timing, as the market plunged for five straight months. Even after regaining more than 10% in a huge October for the market, the US Dow fell almost 7% from May to November — and since then, the average has risen more than 10%.

In 2010, the strategy was almost as lucrative. Shares gained only 1% from May to November 2010, but in the ensuing six months, the Dow had a 15% jump.

Of course, the strategy isn't perfect. In 2009, selling in May caused you to miss out on a 19% jump. But the additional 13% gain from November 2009 to April 2010 helped cushion the blow. But in 2008, the strategy would have let you miss out on a 27% drop.

Even if the strategy doesn't always work, it has seemed to do a reasonably good job recently. So why shouldn't you go ahead and hit the sell button?

A market of stocks
One reason to treat the "Sell in May" strategy with scepticism is that it ignores the investing thesis behind the particular shares you've chosen for your portfolio. Unless you own only index funds, it's important to realise that just because the overall market behaves in a certain seasonal ways doesn't mean that the stocks you own will behave that way as well.

For instance, looking at the stocks in the Dow, McDonald's (NYSE: MCD) has exhibited exactly the opposite behavior as the "Sell in May" rule. Selling McDonald's shares last May would have cost you a 20% return in the following six months, while the shares have only risen 6% since then. The same phenomenon took place in 2010, with a 10-percentage-point difference. For Cisco Systems (Nasdaq: CSCO) , an ill-timed buy in November 2010 cost you a 23% loss, yet selling in May led you to give up on a gain of almost 7%.

With other stocks, the strategy doesn't seem to make much difference. With Procter & Gamble (NYSE: PG) and Wal-Mart (NYSE: WMT), returns from period to period look much the same. In fact, it's easy to argue in both cases that you'd be better off staying in the stock all the time rather than trying to skip in and out of them.

And of course, some stocks do show a "Sell in May" theme. The most extreme is Bank of America (NYSE: BAC), which lost 35%-45% in each of the past two May-to-October periods, only to post gains in the ensuing November-to-April timeframes. It seemed most of the bad news for banking generally came during the second half of the year, while the stock tended to bounce back afterward.

The key here, though, is that there's nothing to suggest which stocks will follow the "Sell in May" rule. The success McDonald's has had overseas has occurred year-round, and Cisco's attempts to turn around ongoing challenges haven't been tied to the calendar. P&G and Wal-Mart may be at the top of their respective industries, but there's no reason why they would defy the rule while their competitors follow it.

Sell for a real reason
If you're nervous about the stock market, lightening up on your stock exposure may make sense — depending on your investing strategy and your current level of risk. But dumping everything on May 1 isn't going to get you the results you need from your portfolio. Only if you know why you're selling can you make a smart decision that's likely to bring you profits over the long haul.

You're far better off taking a long-term approach with your investments.

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The Motley Fool's purpose is to help the world invest, better. Take Stock is The Motley Fool's free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. Click here now to request your free subscription, whilst it's still available. This article contains general investment advice only (under AFSL 400691).

A version of this article, written by Dan Caplinger, originally appeared on fool.com

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