Category: diversified portfolio

Sell in May and Go Away – Should You?

If you’ve been investing for a while, it is very likely you’ve heard the “Sell in May and go away” adage many times. This time every year, all major financial media outlets publish their own pieces on it. The recommendations in such articles range from “it is nonsense – stay invested” to “it’s true and really improves returns”, often also including the very popular “but this year is different”. Where is the truth? Is “Sell in May” just a myth, or does it have a sound foundation? What should you do?
Sell in May and Go Away Origin
It is not known who came up with it first and when. The saying is based on (perceived) stock market seasonality and it generally means that market returns tend to be higher in the first months of a year and lower in the next months. Therefore, it is better for an investor to sell stocks in May to avoid the weaker period that follows.
Unfortunately, the saying is very vague about the exact timing. Should you be selling on the first day of May or the last? Or the 8th May, for instance? Additionally, if you sell your shares, when should you buy them back?
You will find several different variations and interpretations of the saying. Probably the most popular version is one that divides the year into two halves, one running from November to April (better returns – hold stocks) and the other from May to October (stay out). Others suggest you should stay out of the market until year end. Yet another version is “Sell in May and don’t come back until St Leger Day” (the September horse race, or the end of summer).
Are the Returns Really Different?
Despite its vagueness, the “Sell in May” adage (particularly the May to October version) is indeed based on some statistically significant differences between stock market returns in different parts of the year (seasonality). Various studies have been done working with different time periods and stock indices in different countries. Many of them have concluded that there are parts of the year when average historical returns have been higher and volatility lower than in other parts of the year. The month of May seems to be the dividing line between the good and the bad period, although exact date, as well as extent of the return differences, depends on the markets and years included in the research.
In short, historical data suggests that market returns tend to be weaker in the months starting with May, so the “Sell in May” saying does have some foundation. Does it mean you should sell? No, and there are several reasons why not.
Lower Returns vs. Negative Returns
While much of the research shows that returns tend to be lower in summer and early autumn, that doesn’t mean stock investors are, on average, losing money in that period. Although the market declined in some individual years, if you were holding stocks from May to September, May to October, or May to year end every year in the last 20, 30 or 50 years, you would have made money in the end.
When deciding whether to sell in May or not, do not compare the average or expected stock market returns to those in the other period. They must be compared to the alternative use of your capital.
To Sell or Not to Sell in May
When making the decision, you are comparing two scenarios:
1. Stay invested in the stock market. Your return is a combination of the increase or decrease in stock prices and dividend yield (do not underestimate dividends).
2. Sell stocks, invest the money elsewhere (often a savings account or a money market fund) and buy stocks back at some point. Your return is the interest earned, but you must deduct transaction costs, which can be significant and sometimes higher than the interest earned. Furthermore, buying and selling will have tax consequences for many investors.
Returns of option 1 are less predictable and can be very different in individual years, as they depend on the stock market’s direction. Returns of option 2 are more stable, but with transaction costs and today’s low interest rates they will be extremely low or even negative. It’s the good old risk and return relationship.
If your time horizon is long and the outcomes of individual years don’t matter, option 1 (staying in stocks), repeated consistently over many years, will most likely lead to much higher return than option 2. If your time horizon is short (for example, you are approaching retirement), you should consider reducing the weight of stocks and other risky investments in your portfolio – not just in May, but throughout the year.

When Chasing Interest, Don’t Forget Currency Risk

For many years, interest rates have been extremely low in the UK and most other developed countries. If you are living abroad and your new country’s interest rates are much higher than back home, it is natural to think about ways to capitalise on the difference. The right strategy can significantly enhance your returns, but at the same time there are risks which many expats underestimate or completely ignore.
Do You Want to Earn 0.35% or 14.35%?
At present, central bank rates are at 0.5% in the UK and the US, 0.05% in the Eurozone, and negative in several other developed countries including Switzerland, Sweden and Japan. You can get a cheap mortgage, but you also earn close to nothing on your savings. At the same time, the rates are 6% in South Africa, 7.5% in Turkey, 11% in Russia and 14.25% in Brazil, just to name a few.
Why save at 1% or less in a British bank when you can earn multiples of that just by keeping the funds in a different currency? It makes complete sense, particularly when you are living there and big part of your expenses are denominated in that currency anyway.
Interest Rate Differences and Exchange Rate Changes
You have heard it before: There is no free lunch in the markets. To earn considerable returns, you must take considerable risks. In this case, the risk is that the currency you hold will depreciate and the resulting losses will wipe out or exceed any interest gains. This risk is very real. It happens all the time.
Even with the pound’s current weakness, in the last three years the South African rand has lost 38% against the pound, the Turkish lira has lost 34%, the Russian rouble 56% and the Brazilian real 46%. In spite of their high interest rates, you would have lost money on all of them.
According to an economic theory (named uncovered interest rate parity), when there is a difference in interest rates between two currencies, it is expected (other things being equal, which they never are) that the high interest currency will depreciate against the low interest currency, so the total return will be the same on both. For example, if interest rates are at 0.5% in the UK and 14.25% in Brazil, it is reasonable to expect that the BRL will lose approximately 13.75% against the pound in the next 12 months.
Theory and Reality
In reality, other factors come into play. Sometimes the high interest currency does not depreciate that much and you indeed make money holding it. However, other times it loses much more than “expected”, as seen on the examples above.
The risk of disproportionate adverse moves in emerging currencies is particularly high at times of global liquidity shortage and increased risk aversion, such as in the 2008 financial crisis or the 1997 Asian currency crisis, which spilled over and contributed to subsequent problems in Russia, Brazil and Argentina. The problem with these events is that you never see them coming until it’s too late. Furthermore, even an otherwise stable country’s currency can often be affected only due to market sentiment and its emerging status.
What It Means for Your Finances
The above does not mean you should always keep all your savings in GBP or other major currencies. It means that whenever the currency structure of your income, expenses, assets and liabilities is in mismatch, you are exposed to currency risk. For instance, if you are living in Brazil and saving in BRL, but planning to eventually return to the UK or retire elsewhere, you are to a large extent betting your future on the BRL exchange rate.
Make sure you know what you would do in an adverse scenario, such as a currency crisis, however unlikely that might seem at the moment. Keep at least a portion of your savings in a strong and stable currency, even when the returns don’t look that attractive. It is widely known that rich families in places like China or Russia prefer to keep big parts of their wealth in developed countries, giving up the higher returns they would earn at home. They do it for a reason and that reason is safety and stability.
You can allocate some funds to high-yield currencies and riskier investments, but with the core of your assets, like the pension pot, it should be defence first. Don’t bet your future lifestyle.