Sell in May? Only If You Like Paying Taxes!

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The stock market’s rocky start to May, coupled with Federal Reserve Chair Janet Yellen’s comments that stock valuations are “quite high,” has some investors wondering if they shouldn’t follow the old adage to “Sell in May and stay away.”

Various pundits have tweaked the data, or ignored certain real-world concerns to make the “sell in May” mantra look a lot more attractive than it is.

Don’t buy the hype.

I put the “sell in May” strategy — which at its most basic requires that you rotate holding stocks and cash every six months by selling stocks at the end of April and buying them back at the end of October — to the test. I ran the numbers using Vanguard 500 Index Fund (MUTF:VFINX) and Vanguard Prime Money Market Fund (MUTF:VMMXX) with data from October 1976 through the end of April 2015.

sell in may

Growth of $100 in Vanguard 500 Index, the “sell in May” strategy (holding 500 Index from November through April and Vanguard Prime Money Market from May through October), and the same strategy after paying a 25% tax on all gains from October 1976 through April 2015.

At first blush, there does appear to be something to selling in May and going away. And this is about where most proponents of the strategy end the discussion.

You see, during the November-April period when you are holding stocks, the Vanguard 500 Index Fund returned an average 8.4% compared to an average return of 3.3% over the May-October stretch. Furthermore, the “sell in May” approach, despite holding cash half of the time, grew at a 10.9% rate, very nearly matching the 11.1% annual rate of buying and holding VFINX over the entire period.

That sounds pretty good … again, at first blush.

Unfortunately, what you have to know is that over a full 12-month period, the “sell in May” strategy only worked a third of the time. In other words, two out of every three years, stocks beat cash in the May-October period. In fact, on average, as I noted before, Vanguard 500 Index Fund returned 3.3% during the May-October period, versus a 2.7% return for Prime Money Market.

The low success rate of the “sell in May” strategy isn’t merely academic. The numbers I ran assume you followed the strategy to the letter.

But reality has a nasty way of making the averages look a whole lot nastier than the numbers suggest. In fact, following a “sell in May” strategy over the past 40 years or so would have required nerves of steel and an unwavering commitment that I doubt most investors could muster.

For instance, leaving the safety of cash and buying stocks at the end of October 1987 with Black Monday still fresh in investors’ minds would not have been easy. Nor would it have been easy to sell stocks at the peak of the tech bubble in April 2000, particularly given that the strategy had failed in eight of the nine prior years.

In short, back-tests are one thing, but investing real money is quite another.

The other issue that most people forget about when looking at various market timing strategies is the tax cost of implementing the trades. The reality is that the short-term gains and income taxes that selling in May creates are a headwind that cannot be overcome in a taxable account. And again, I believe most investors would be loath to gamble their retirement money — those IRAs and SEPs they’ve spent so long building — on a timing strategy with such a rocky history.

Again, I did the math, applying a straight 25% tax rate to all gains and income the strategy generated. Not surprisingly, this cut returns by more than half over the 38-year period I examined.

“Sell in May and stay away” might have a nice ring to it, but in fact, it’s almost impossible to implement successfully.

Market timing doesn’t work, particularly once you factor in taxes, fees and frequent failure.

Editor/Research Director Jeffrey DeMaso helps publish The Independent Adviser for Vanguard Investors, a monthly newsletter that keeps abreast of recent developments at Vanguard, and the annual FFSA Indepedent Guide to the Vanguard Funds.

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Article printed from InvestorPlace Media, https://investorplace.com/2015/05/sell-in-may-and-go-away-taxes/.

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