David Prosser discusses an old wives’ tale and income advantages of investment companies.
The thing about old wives’ tales is they invariably contain some grains of truth. So it is with the often-ridiculed advice to stock market investors to “sell in May and go away”. Those who heed the warning and “don’t come back till St Leger Day” in mid-September are breaking all the rules of long-term investment, we are told – but what if they really are better off doing so?
The pearl of wisdom behind this hoary old adage is that the summer months see City professionals take their holidays or abandon work for a series of jollies at sporting events; they’re out of touch with the markets, trading volumes drop and volatility increases.
In the age of the mobile phone and the internet this seems utterly out of date and irrelevant. But here’s the thing: since 1986, the UK stock market has lost ground between the start of May and mid-September on no fewer than 15 occasions. That’s 45 per cent of the time. In other words, investors religiously following the sell in May rule would have avoided a loss more or less every other year.
Perhaps those old wives of the stock market aren’t so daft after all. If there’s a roughly one in two chance of losing money in the markets during a fixed period of the year, isn’t it worth at least considering steering clear?
Maybe, but the conclusion of such considerations should be that staying invested makes sense after all.
There are several reasons for this. First, while the data points to loss-making summers in 45 per cent of the years since 1986, that still means investors in UK equities made money 55 per cent of the time. With no way of knowing which will be the up or down summers, the odds of ending up better off overall are against you.
In fact, data from Hargreaves Lansdown suggests that £10,000 invested in the UK stock market would today be worth around £198,000 if the money had just been left there. By contrast, if you’d cashed in each May and reinvested in September, your £10,000 would have grown to only £125,000.
One reason for this is alluded to in a study by Fidelity Investments highlighting the very significant cost of missing out on particularly strong days for the market, some of which are bound to occur over the summer. It suggests that the 9 per cent annual return delivered by stocks, on average, in recent decades, would have been reduced to less than 7 per cent if you’d missed just the 10 best days of market performance during this time.
Another hugely important consideration is the contribution made by dividend income to stock market returns. Those who reinvest the dividend income they earn on their holdings secure substantially better performance over time, roughly doubling their returns in the UK stock market over the past 30 years. But if you’re out of the market for extended periods of the year, you miss out on dividend payments made during these times – and many companies make distributions over the summer.
All of which is to make the case not only for staying invested but also for choosing your investment vehicle carefully.
In particular, investment companies offer an attractive way to manage the highs and lows of the British summer. One reason for this is the low-cost regular savings schemes most investment companies offer. These give you access to “pound-cost averaging”, a statistical quirk that could prove valuable in years when the market drops between May and September. During such down periods, your fixed monthly payment into the fund buys more shares, helping you to recover more quickly from losses as the price rebounds; it’s a way to smooth out volatility.
The other advantage of investment companies in this context is their outstanding record for delivering income. Whether you want to draw down some of that income or reinvest all your dividends, investment companies’ consistent record of pay-outs – enabled by structures and freedoms unique to the closed-ended sector – makes them especially valuable.
Indeed, analysis published this month by the broker Stifel points out that there are no fewer than 31 equity-exposed investment companies offering dividend yields of more than 4 per cent. Such generous levels of income provide plenty of comfort for those worried about what the summer months might have in store.