The Best Days of the Month to Invest
- Austin Pryor
- 2012 13 Jun
Here's some research that should get your attention. Assume two $1,000 portfolios — which we'll call the Green and the Red — were started in January 1927. Although the market is open, on average, about 21 days each month, the Green portfolio was invested in stocks only during a certain "favorable period" of seven days that recurs each month. Then the stocks would be sold and the Green portfolio would be invested in Treasury bills until the next favorable period rolled around.
The Red portfolio, on the other hand, was invested in the opposite fashion, owning stocks only during the 14 or so other days each month, the days when the Green portfolio was sitting on the sidelines. Think of this as an "unfavorable period."
Neither Green nor Red added to their original $1,000, and they continued their crazy competition down through the decades until 1990 (which is as far as the original research went) when they totaled up their gains from 64 years of investing.
The Green portfolio, which was invested only one-third of the time, grew to a staggering $4,400,000! And the Red portfolio, which was invested twice as many days each month as the Green, saw its original $1,000 shrink to a meager $433! (Commissions and taxes have been omitted to dramatize the point.) Pretty amazing, huh?
The existence of a monthly favorable period and its use as a timing tool was first popularized in the 1970s in a book called Stock Market Logic, by Norman Fosback. He called it "seasonality," and defined it as (here's the part you've been waiting for) the last two trading days and first five trading days of each month.
In 1990, the scholarly Journal of Finance published a paper by Joseph P. Ogden of State University of New York. He offered an explanation of why this monthly seasonality might take place.
Professor Ogden's research discovered that 45% of all common stock dividends, 65% of all preferred stock dividends, 70% of interest and principal payments on corporate bonds, and 90% of the interest and payments on municipal bonds, is paid to investors on the first or last business day of each month. All this is in addition to the month-end contributions into 401(k) and other retirement savings accounts. Dr. Ogden concluded that this "regularity of payments" was responsible for the seasonality phenomena.
Subsequent research, however, has shown that neither the stock market's trading volume nor net mutual fund cash flows increase during the turn of the month period, which seems to refute Ogden's hypothesis. Still, the effect has continued to persist, not only in the U.S. market but also across multiple countries (30 of 34) studied (see the 2006 article, "Equity Returns at the Turn of the Month," by Wei Xu and John J. McConnell—PDF).
Yale Hirsch, publisher of the Stock Trader's Almanac, believes the growing awareness among investors of the monthly favorable period caused it to change, beginning in the mid-1980s. As more investors tried to get in ahead of this monthly rally, it had the effect of causing the rally to begin sooner. Hirsch says the pattern has been altered so that the new seasonality shifted to the last three trading days of any month and the first two of the next month.
SEE ALSO: Diversifying Your Stock Investments
Thankfully, for the investor using a monthly dollar-cost-averaging strategy, it doesn't matter which interpretation of the theory is precisely correct. (Dollar-cost-averaging is the practice of investing the same amount of money at regular time intervals, usually monthly.)
Just do your buying before the other month-end investors start theirs, say on the fifth-to-last trading day of the month. Then, whether the Hirsch theory (seasonality begins with three trading days remaining in the month) or the Fosback theory (seasonality begins with two trading days remaining in the month) is correct, you'll still benefit from the buying that surrounds the turn of the month.
For example, the last seven days in September fall as follows: 24th Friday, 25th Saturday, 26th Sunday, 27th Monday, 28th Tuesday, 29th Wednesday, and 30th Thursday. Since the financial markets are closed on the weekends, the final four trading days in September will be the 27th-30th. In that event, you would want to make your investment no later than the day before the 27th — in this case, on Friday the 24th. If you have your money at a fund organization or broker, a timely phone call or click of the mouse will transfer it into your stock fund on the day of your choosing each month.
If you set up an automatic transfer that is executed on the same date every month, you'll give up a little precision because the seasonal period varies from month to month depending on where weekends fall and the number of days in the month. In that case, we suggest using the 24th of the month, for the reason seen in the prior example. That date will be close on target during months that have 30 days, and a little early in other months (except February). This will be close enough to still provide a benefit.
Here are a few other ways you can use monthly seasonality to improve your long-term performance.
• Perhaps you're in retirement and part of your income derives from selling enough of your stock funds each month in order to withdraw $500. Wait until the favorable period has run its course; sell your shares on the fifth trading day of each month. Over the long-term, you'll get a slightly better average price.
• Following a variation of the dollar-cost-averaging strategy, use favorable periods when investing a windfall (for example, an inheritance). If you haven't been investing regularly, it's a little scary to take a large sum and put it into the market "all at once." Divide it into several smaller amounts of equal size, depending on how long you want to stretch things out.
For example, if you want to invest it over a period of six months, divide your total into six equal amounts. Then invest one-sixth each month just before the start of the favorable period.
• The monthly seasonality concepts also work well in conjunction with the annual seasonality strategy explained in on our Advanced Strategies" section.
Remember, these patterns aren't perfect. The seasonality studies reflect "averages." By definition, an average finds the middle ground (and therefore hides the extremes). So don't expect the favorable period to lead to higher prices every month.
As J.P. Morgan famously said, the only thing we know for sure about next month's market is that "stocks will fluctuate." Seasonality should be used only as one piece of an overall decision-making process.
By Austin Pryor for Sound Mind Investing
Publication Date: June 13, 2012