The authors discuss the best periods to invest in stocks for the greatest rate of return.
by Marvin Appel, PhD and Brian C. Hufford, CPA, CFP
The emphasis for this series is less on theory and general market forecasting and more on practical advice and specific investment strategies. This month, we will discuss a basic strategy for seasonal investing, using examples that have had excellent long-term records, to determine the best periods in which to accumulate stocks.
Seasonal influences on stock market behavior are well-documented. For example, the stock market historically has shown above-average daily performance during the two days immediately following the end of the month. The day before a market holiday usually has better market performance as well. These patterns may be of use to very active traders, but for most of us, long-term seasonal influences are more significant. Here is one pattern that is likely to prove useful to a large number of investors. This pattern can help you place and maintain your capital in the stock market during the time of the year considered most favorable to stock ownership. Likewise, it should help you restrain from investing during those periods that have, historically, proven to be the least favorable.
Six months to invest; six months to be cautious
This pattern does not hold true each and every year. However, for more than three decades, the period from the very end of October to the first few days of May has been far more productive for stock ownership than the period following the first days of May to the end of October.
In fact, almost all of the stock market gains that have accrued over the past 30 years have taken place during the favorable late October to early May period. Unfavorable periods — May-October — have produced relatively minimal rates of return over the years.
Returns in this period historically have been less than those that could have been attained from risk-free investments, such as commercial paper, money market funds, or treasury bills.
Simply put, your best investment strategy is to purchase securities on the second-to-last trading day in October. Sell on the closest trading day to May 4 of the following year. If May 4 falls on a Saturday, then sell on the previous trading day. If May 4 falls on a Sunday, sell on the first trading day thereafter.
Stock market performance during both favorable and unfavorable seasonal periods has followed a pattern. The average gain during favorable six-month periods from 1969-2000 has been 7.79 percent. If you invested in the stock market only during such periods, your compound rate of return would have come to 7.24 percent per year (excluding interest from cash and dividends while holding stock).
The average gain during unfavorable six-month periods came to only 1.29 percent. Had you invested in stocks only during unfavorable periods, your capital would have appreciated at an annual rate of .96 percent per annum (dividends excluded), clearly less than rates of return achievable from risk-free investments.
An initial investment of $10,000 held in stocks only during favorable periods would have grown to $91,771.36. An initial investment of $10,000 held in stocks only during unfavorable periods would have grown to just $13,540.93.
Comparison to buy/hold strategies
If we presume that you were invested in the S & P 500 Index on a buy and hold basis over 31.7 years, an initial investment of $10,000 would have grown to $124,267 at an annualized compound rate of return of 8.27 percent (dividends excluded). If we presume that you had been invested in the S & P 500 Index only during favorable periods, receiving prevailing commercial paper returns during unfavorable periods, your initial investment of $10,000 would have grown to $282,448, an annual compound rate of return of 11.1 percent (stock dividends excluded). It should be noted, however, that if dividend payouts had been included in the above calculations, differences between buy and hold and seasonal investing would have narrowed somewhat. We are crediting seasonal investments with interest payments while accounts were in cash; we are not crediting the buy and hold strategy with dividend payments over the same periods.
That said, it should also be noted that the greatest percentage of strong market advances have taken place during favorable seasonal periods. The majority of unfavorable periods actually have shown market advances, but of a lesser magnitude.
Although there has been a definite and helpful bias toward stock market investments during favorable seasonal six-month periods, there have also been unprofitable results during some such periods. (In future articles, we will show how interest rate data and other indicators can be employed to reduce risk.) At times, stocks have advanced well even during unfavorable seasonal periods. And finally, portfolios outside of tax-sheltered structures (i.e., IRA accounts) would incur unfavorable tax consequences over the long run compared to buy and hold strategies due to portfolio transactions.
Investors may or may not wish to exactly follow the seasonal strategies discussed in this article. However, timing purchases and/or sales of securities to coincide with long-term seasonal tendencies of the stock market can improve the performance of your accounts.
(Note: Our appreciation to Yale Hirsch, publisher of The Stock Trader's Almanac and numerous other reports, and to Sy Harding, publisher of the Street Smart Report, for studies that stimulated this article.)