Why ‘selling in May’ could damage a passive income portfolio

Jon Smith explains why the old investing adage doesn’t apply for passive income investors wanting to build long-term wealth.

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There’s an old adage in financial markets to “sell in May and go away”. This is based on the view that stocks typically underperform in the six months following May, relative to the six months leading up to it over the winter. In reality, there’s no guarantee of future performance based solely on the past. I’ve seen different studies done that prove or disprove the theory! Yet for a long-term investor focused on passive income, here’s why selling in May isn’t a good call at all.

Selling existing holdings

At a basic level, selling stocks in May deprives an income investor of future dividends. The primary aim for this type of investor isn’t short-term share price gains, but dividend income built-up over time. Given the way companies declare dividends, people need to own the stock well in advance of the dividend being paid. I can’t simply buy it the day before the payment date and receive the income.

This means a dividend could be payable in June or July, but the stock needs to be held in May in order to receive it. Not only this, but some stocks only pay dividends every six months. If an investor cuts out stocks this month with the aim of repurchasing in the summer, another dividend might not be due until the end of the year.

Losing out on compounding

One of the key ways to accelerate the growth of a passive income portfolio is compounding. This means that when a dividend is paid, the investor takes the money and immediately buys more shares in the business. This holding builds up over time, paying out more and more income as the shareholding increases.

If someone sells in May, buys in August, sells in October, there’s no potential to benefit from compounding. It fragments and causes unnecessary problems with reinvesting dividends. It means time out of the market, which is the time needed for money to compound!

The opportunity cost of selling

Let’s say an investor decides to sell everything in May, with the goal of buying stocks at much lower levels at the end of the summer.

If the market does significantly fall in this period, then it was a great move. Occasionally, this does happen (hence the phrase). Yet what about the cost of other scenarios?

If the market stays flat, the p has missed out on several months of income potential. Worse still, if the market rises, they’ve lost out on both the income and also have to pay more to buy the same stocks. So two out of three possibilities are negative for an income portfolio.

Time in the market versus timing the market

For those who feel they can time the market perfectly, being active does have benefits. Yet for the vast majority of investors, spending time in the market is the best way to achieve long-term results. This is especially true when building a passive income portfolio.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Jon Smith has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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