Back-to-school prep for your portfolio

If students dread the coming of September, so do some investors: it’s typically the worst month of the year for stock performance.

But the so-called September effect may or may not be something that people actually need to fear.

The numbers over the years

The history books don’t show September in a great light: the month has seen an average decline in the Dow Jones Industrial Average of 1.1 per cent since 1950, while the S&P 500 has averaged a 0.7 per cent decline during September. Nasdaq’s composite index has fallen an average of 1 per cent during September trading since it was established in 1971.

Although several theories attempt to explain the phenomenon, financial experts say it’s important to put those numbers into context.

“The average percentage up and average percentage down in September is almost identical to every other month,” says Phil Knight, associate portfolio manager at RBC Dominion Securities Inc. in Vancouver. “The problem is there have been a couple of really bad Septembers, like in 1987 [when the stock market crashed], and that’s made the average loss slightly worse than the others.”

There are other salient events that have contributed to September’s below-average performance over time: the 9/11 terrorist attacks and the 2008 Lehman Brothers bankruptcy, for example.

Some theorists point to the fact that summer months usually offer light trading volumes because of holidays, and once fall arrives, investors sell positions they’d been planning on unloading. The market then experiences increased selling pressure and a resulting decline. Another possible contributing factor is that mutual funds have their fiscal year-end in September, and fund managers typically sell losing positions before year-end.

“Some credit tax-loss harvesting as the culprit, while others believe that sharp drop-off in the amount of daylight in New York in September might trigger seasonal affective disorder and make some traders more risk-averse,” notes Robert Stammers, director of investor education at CFA Institute. “However, most of the theories trying to rationalize the September effect point to correlation, not causation.”

And there have been some outstanding Septembers: In 2010, for instance, it was the highest performing month with the Dow Jones Industrial average posting gains of 7.7 per cent. “It was the best September on record for the last 75 years,” Stammers says.

Plus, poor performance in the past is no guarantee of lousy outcomes in the future.

“September is probably not as bad as it’s made out to be,” Knight says. “But if people expect it to be bad, they’re more nervous.”

How to prep your portfolio

Identify your goals

If you’re a short-term investor, a poorly performing September can be an opportunity. But long-term investors need to be specific about what their goals are.

“When goals are determined, then a portfolio can be constructed to achieve those specific financial objectives,” Stammers says. “Ensure that each security or asset class has a role in the portfolio’s objective to achieve specific goals. As long as they’re expected to maintain their role in the portfolio there is little reason to substitute investments or investment exposures unless there are fundamental changes in the economy, the business environment or the capital markets.”

Determine your risk tolerance

If your portfolio is designed to minimize risk, then an expected drop in stock prices shouldn’t create anxiety.

“If you know you can’t handle more than a 10 per cent drop in your portfolio at any given time, that is your measurement of risk,” Stammers explains. “You need to build your portfolio so it limits that possibility. If September comes and your portfolio is set so that’s it’s not going to be affected that much by a big swing in equities, then you’re really okay. You may see a drop in your portfolio, but it’s within your risk parameters and it really shouldn’t affect you.”

Diversify

Diversification allows you to spread your investments among many different securities, which significantly reduces risk. “The greater diversification among securities and asset classes, the less impact of anomalies like the September effect,” Stammers says.

Sit tight

The worst thing investors can do is make reactive changes to their portfolio, especially on a monthly basis. Rather, think long-term.

“If you look to people who manage hundreds of millions of dollars, which would be pension funds in Canada and the United States and institutions in Canada and the United States, none of them sell their stocks in September,” Knight says. “So if the biggest and best … investors in the world don’t sell in September, why would we?”

If you’re itching to unload, Knight suggests not selling an entire position but rather selling only profit from existing positions.

“If you started with $10,000 in a … stock and it went up to $15,000, sell $4,000 or $5,000,” he says. “If the market goes down you’ve only taken the profit out but still have the original position, so if the stock goes up, you’ve covered all the bases.

“Also, by selling out you out give up all dividend income, and over time that makes a huge difference to your return.”

He recalls Warren Buffett being asked years ago for his advice on how long to hold a stock for. “He was asked what his favourite holding period was, and his answer was ‘Forever,’” Knight says. “He just rode out the markets when they were going up, down, and sideways. Ultimately, if you buy good stuff and can do that, the ins and outs of the individual months don’t matter that much.”