Let’s start with a reminder that equities and fixed income instruments don’t respect the Gregorian calendar. Why should it? At what point does the fact that a year consists of about 356 days, and further divided into twelve months of more or less 30 days each, be considered a reason for selling stocks? This is not a concept of particular interest to Mr. Market. It is also a concept that should remain off the radar of investors, especially those with retirement accounts.
A brief history of time for investors
Conceptually, we call the time it takes for the earth to complete a full rotation on its axis a “Day.” The time it takes for the earth to complete a full rotation around the sun is called a “Year” during which period almost 365 days occur. The actual starting point of this cycle began around four billion years ago and as such remains a bit of a mystery. That this idea of a year being divided into twelve-month segments that have some kind of significance can be blamed squarely on ancient Egypt. Not only were the Egyptians responsible for the calendar as we understand it, they also suggested a start and finish to the year for help with planning around the annual flooding of the Nile. But they also invented tax collection, another questionable practice (as a side note, they also invented beer as we know it, and I’ve long been suspicious there’s a connection between this simultaneous appearance of beer and taxes). Today, as a recent article in National Geographic demonstrated, religion can also play a role in setting the start and finish of a year; March for Hindus, September for Jews and Muslims.
To tax, or not to tax
In tax-deferred and retirement accounts, no changes should be made just because the calendar says it is December. Or March, or September. Long-term investments are as oblivious to a twelve-month calendar as Mr. Market. As for investment transactions made in taxable accounts, there might be reasons for things like selling stocks to “harvest tax losses” but this often has the feel of market timing. Yes, you can sell a stock for a loss on December 30 and use that credit to avoid paying some taxes on profitable equity trades you’ve made. But why would you sell a stock with long-term potential for a short-term benefit? And if it was a crummy investment, why wait until year-end to sell? Unlike the Ancient Egyptians, you can “tax harvest” at any time.
So please don’t make a bunch of trades in your IRA or 401K retirement accounts because it’s the holiday season. Or because of decisions made by an Italian pope named Gregory in 1582 that subsequently provided the U.S. Internal Revenue Service with a framework for how to start taxing incomes to pay for the U.S. Civil War. Of course, we all know that taxing incomes in 1862 was just a temporary action initiated by Congress that couldn’t possibly endure since so many citizens were opposed to the idea.
What about stock markets next year?
Now, having said all of the above, let’s ruminate on S&P 500 returns for the year that was, and the year ahead. Knowing now that an artifice like the Gregorian calendar doesn’t have any relevance you can confidently declare a better reason for all those December sales of stocks in your retirement account. Everyone knows that after a big year like 2017 – likely to finish the year up around 20% – the next year will likely be not so good. This could be an unfortunate assumption.
As clearly demonstrated by the Boys at Bespoke (highly recommended), the performance of equity markets over time has about the same predictable correlation as flipping a coin; none. In fact, comparing index performance year-over-year is falling victim to the same bias; that Mr. Market has an internal clock and a memory. Comparing 12-month results from December to December will vary dramatically from comparing results from August to August. The S&P 500 had a very good year in 2016, up almost 12%, with most of the gains coming in the 4th quarter. Certainly, a signal to sell going into 2017, right?
As for next year, well, if you’ve built a well-diversified portfolio of indexed funds anchored around a core holding like the S&P 500, your returns are likely to benefit from the fact that markets tend to rise more than they fall. In the final analysis, it’s about building wealth over time, not market timing to get rich quick.