Can This Classic Market Wisdom Make You Rich?
Stock market investors love to throw around aphorisms, folk wisdom, and other “unwritten rules” that they swear by. And rookie investors, desperate for any edge in the market, are often keen to put this wisdom into practice. But is there anything to these investing axioms?
Here are three popular nuggets of investing wisdom — and the truth behind them.
“Sell in May and Go Away”
This rule is grounded in the idea that investors vacation and ignore their investments in the summer, leading to lower trading volume and reduced summer returns.
To find out whether this idea is lore or reasonable investment advice, take a look at this recent study that revealed stock market returns were 10 percent higher during the November to April half year than the May to October period.
To capitalize on this finding, Fuerst and his colleagues suggest doubling stock market exposure during the November to April months, and to hold Treasury bonds throughout the May through October months.
This sounds easy enough! But it’s important to remember that you’ll encounter tax consequences with this short-term buying and selling. And it’s also worth noting that this strategy doesn’t work every year. In fact, this year, your returns would fall behind the market if you sold in May.
In general, frequent trading leaves you open to allowing your emotions to guide your investing. If you’re a long-term, buy-and-hold investor, then you’re probably best off staying invested in the market rather than pulling your money out to try and time the market based on this historical trend.
“Don’t Confuse Brains With a Bull Market”
Originally stated by Humphrey Neill, founder of the Contrary Opinion Forum in 1963, this adage refers to investors who attribute their stock market gains to their own brilliance, rather than broad stock market trends.
While markets go up and down, the long-term trends have been upward.
As such, most investors will find their investments growing — and that’s especially true if they’ve been in a sustained bull market for some time. If you were invested in the market during the past eight years, you probably would have seen positive stock market returns; and unless those returns significantly outperformed the indexes during this period, your investing success wasn’t attributable to your own intelligence, but to overall market forces.
So, we’ll mark this one as true. Accept that investing with the overall market in the past has led to substantial long term returns for the patient, and don’t let a sustained run of success convince you that you’re a stock wizard.
“Don’t Fight the Tape”
This unwritten rule of investing refers to the recommendation that investors shouldn’t trade against a trend. The “tape,” or ticker tape, reflects the streaming report of changes or ticks in stock prices. The rationale for this investing rule is based upon momentum theory which states that a trend will continue. So, according to “don’t fight the tape”, if stocks are trending upward, they’re likely to continue in that direction.
In general, this isn’t bad advice. But remember that stocks don’t continue in one direction indefinitely, and at some point, a bull market will turn into a bear market.
The problem for investors is that no one knows when the shift will occur.
Final Decision: Should You Invest According to the Unwritten Investing Rules?
Like most adages, these unwritten rules of investing have at least some truth to them. But they shouldn’t be the basis of your investment strategy. You’re better off crafting an investment portfolio and maintaining asset allocations in line with your age and risk tolerance. This way, when markets go down, your diversified investment portfolio includes a cushion of fixed investments to soften the negative stock market returns.
As legendary value investor Benjamin Graham once said, “In the short run, the market is a voting machine, but in the long run it is a weighing machine.” In other words, in the near term, the markets are driven by psychology and emotion – and maybe even by some of these unwritten rules — but in the long term, stock prices reflect the underlying value of the company.
Barbara A. Friedberg is a former portfolio manager and university investments instructor. Her writing appears on various websites including Robo-Advisor Pros.com and Barbara Friedberg Personal Finance.