Investment maxims: Truth or myths

Investment maxims: Truth or myths

Despite concerns over the weakening global economy, stock markets around the world have rallied since the start of the year.

The Dow Jones Industrial Average is near record highs while the local Straits Times Index (STI) recently rose above the 3,400-point level, for the first time since January 2008.

No wonder some analysts are preparing for a possible correction and trotting out the well-used line "sell in May and go away" in recent weeks.

But is there any truth in such sayings? Or are they pure myths?

The Sunday Invest takes a look at five popular sayings in the investing world and analyses the merit, if any, to these adages.

#1 Sell in May and go away

One of the most popular sayings being tossed around during this period is for investors to stop putting money into the stock market in May, cash out their holdings and start trading only in October.

This is based on observations that the stock market tends to do worse between the months of May and October, compared with other months of the year.

This advice is not completely without merit.

In 2001, the bursting of the dot.com bubble saw the STI fall by 23 per cent from May to October. In 2008, the financial crisis saw the index plunge 43 per cent over the same period.

So is it true then that May to October is a bad period for shares, and that the maxim is a useful strategy to employ?

In fact, over 13 years since 1999, the STI advanced seven times during May to end-September. When it came to declines, the STI fell six times during the same period.

In a report that looked at US stock data since 1871, research firm CXO Advisory showed that if an investor used the simple buy and sell strategy, it would beat the "sell in May and go away" method by a huge margin.

In the buy and hold strategy, $1 grew to nearly $200,000. The sell in May and go away strategy yielded about $1,000 over the same period.

Aberdeen Asset Management's head of Asia-Pacific strategy and asset allocation Peter Elston says: "There is a perception that the middle part of the year does worse than other periods. But clearly holding cash for a fixed amount of time is inferior to staying invested in the market."

Verdict: Mixed when it comes to historical data and fares even worse when employed as an investment strategy.

#2 Buy and hold

So is buy and hold, then, the best strategy for investing in the stock market? This strategy has often been articulated as a sure-win to get wealthy, but only over the long term.

Based on over 100 years of US stock data, if you had put in a dollar in 1871, you would get roughly $200,000 now.

Likewise, if you had started investing $1,000 in the local stock market back in 1987, you would get about $4,000 today.

Professor of finance Benedict Koh from the Singapore Management University's Lee Kong Chian School of Business notes that such a strategy is a passive one because transactions are kept to a minimum.

"To reduce volatility, investors should buy and hold a diversified portfolio of stocks spread across different industries," he says.

Value investors such as Benjamin Graham and his most famous disciple Warren Buffett believe strongly in such an approach.

To them, buying a company is about buying into its intrinsic value, says Mr Elston. "The business, and its ability to generate profits, is what should be valued and not the stock price."

But critics of such a passive strategy point out that Mr Buffett has billions of dollars in cash to tide him over even if the stock market is deep in the red.

OCBC's wealth management vice-president Vasu Menon says a better approach would be to adjust one's portfolio in today's much more volatile world. Taking profits when the opportunity permits also allows investors to lock in profits.

For instance, the STI was trading at around the 800 level in September 1998 and is at around 3,400 now, representing a significant 320 per cent total return in almost 15 years.

"But an investor who had ploughed his money into the STI in September 1998 could have done very well if he had locked in profits just 15 months later as the index had surged more than threefold to about 2,600 in January 2000, at the height of the technology fervour," he notes.

If the investor had waited another four years, his profits would have been much less, with the STI trading at around the 1,800-point level in 2004.

Says Mr Menon: "If the original premise for your investment changes and the fundamentals take a significant turn for the worse, it may be better to liquidate your holdings before your investment horizon runs its full course, even if it means suffering losses." Verdict: Mixed at best, although timing the market is also not the easiest thing to do.

#3 The markets are efficient

The advent of electronic trading has brought trading down to the nanosecond, with some high-speed traders making a living out of trading in between trades.

With information now efficiently disseminated, there is a strong view among some asset managers that there is no point trying to pick stocks.

Passive investing through vehicles such as exchange-traded funds (ETFs), which track indexes of key stock markets at a low cost, will bring about better returns, says this group of investors, led primarily by ETF managers such as Vanguard and Blackrock.

Studies do seem to back this up.

Prof Koh notes that a variety of studies of mutual fund managers in the US showed that the majority of managers did not do as well as their benchmark indexes.

Purchase this article for republication.

BRANDED CONTENT

SPONSORED CONTENT

Your daily good stuff - AsiaOne stories delivered straight to your inbox
By signing up, you agree to our Privacy policy and Terms and Conditions.