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Jasmine Birtles
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Investing: What is the January Effect?
Reading Time: 5 minutesThe ‘January Effect’ suggests share prices typically rise at the beginning of the year. But is there any truth to the theory? And if so, how can the January Effect be explained?
Keep on reading to discover all the details or click on a link to head straight to a section…
- What is the January Effect?
- Is there any truth to it?
- How can the January Effect be explained?
- Should you buy shares in January?
what is the January effect?
The January Effect refers to a suggestion that shares (particularity small-caps) rise during the month of January.
In other words, the January Effect is a market timing strategy which suggests the time of year can have an impact on the performance of stocks and shares.
The theory is essentially similar to the ‘Sell in May and go away’ adage. This saying recommends that investors offload shares in May and buy them back in early Autumn.
Is there any truth to it?
Whether or not the ‘January Effect’ is real is hotly debated.
Search for the term online and half of the results suggest there’s no truth to it. Meanwhile, the other half will claim the theory holds value.
What we do know is that the January Effect was first coined by Investment baker, Sidney Wachtel, back in 1942. During this time Wachtel claimed that smaller stocks usually outperformed larger stocks at the turn of the year.
One study did actually prove this to be the case for a 70-year period until roughly 1975. In this research it was found that stock returns were found to be five times higher than average during the month of January. However, the study also suggested the trend applied to all stocks, not just smaller-cap ones as proposed by Wachtel.
However, a different study by investment giant, Goldman Sachs, painted a different picture. Its research looked at European stock returns between 1999 through to 2017 and concluded the January Effect was no longer significant. Interestingly, returns during the period of research were found to be lower in January (-0.5%) compared to average returns for the other months of the year (+0.2%).
Despite Goldman’s research rubbishing the theory, we shouldn’t forget that the investment bank only studied stock market performance for a mere 20 years. Plus, there are other studies that do support the existence of the January Effect.
How can the January effect be explained?
If you believe in January Effect, and you don’t believe it to be a random occurrence, then there are several explanations as to why stocks seemingly rise at the turn of a new year. Let’s take a look at each of them
1. Tax reasons
At the end of the year investors may be tempted to undertake tax-loss harvesting. This is a strategy where investors sell shares at a loss in order to reduce their liability for capital gains tax. When the new year arrives, investors may then be tempted to re-buy their shares.
If this happens at scale, then this tax-harvesting activity can push up share prices in January.
Capital gains tax applies in both the UK and USA. The UK ‘celebrates’ the start of a new tax year on 6 April. Across the pond, however, the new tax year begins on 1 January.
It’s worth knowing that the UK capital gains tax threshold will be cut to just £3,000 for the upcoming 2024/25 tax year.
2. Investor sentiment
We shouldn’t forget that the stock market isn’t particularly rational and investor sentiment can certainly influence the performance of equities.
For example, if investors feel positive at the beginning of a new year – perhaps because there’s a general feeling in the air that the coming year will be a a good one for economy – then it’s likely they’ll be tempted to buy shares in January.
While investors may be swayed by their emotions throughout the year, it’s probable that the start of a new year is the time when most investors will take the time to reflect, and decide how they will invest for the next 12 months and beyond.
3. Year-end bonuses
Christmas and/or end of year performance bonus’ are typically paid to employees in December.
While some of this cash may be put towards last-minute festive gifts, or other frivolous spending, it’s likely that some of this capital will be directed into the stock market. This can may help to boost the value of stocks and shares at the turn of a new year.
4. End of year results
Results for the final quarter of the year are typically released mid to late December. Active investors may turn towards performance reports in order to assess whether or not to invest in a company.
For example, if an organisation posts strong results in December, investors may be inclined to pile in and buy its shares. This is another factor that may help to explain why stocks may rise in January.
Should you buy shares in January?
There’s no set answer to whether you should buy (or sell) shares in January. That’s because the answer to the question will ultimately depend on your investing strategy.
Long-term investors
If you’re a long-term investor you probably shouldn’t be too concerned about finding the perfect time to invest. That’s because you should be thinking about ‘time in the market’ as opposed to timing the market.
To put it another way, if you invest for the long term you’re hoping your portfolio will rise over many years, or even decades.
And because you plan to invest for a long period, there’s every chance your portfolio will suffer the odd bump or two. You may even experience a stock market crash. However, the key to investing with a long-term mindset is to keep going, and not lose sight of your investing goals.
The point is, picking the ‘correct’ month to invest shouldn’t really be much of a factor if you’re a long-term investor.
Short-term investors
If you’re more of a trader than a long-term investor, then you may feel that timing the market is more important for you. However, buying and selling shares solely because of the time of year is unlikely to be a highly successful strategy.
It’s best not to be caught up in historic patterns. Instead, it’s probably worth focusing on your own trading strategy, and doing your normal – hopefully thorough – analysis before deciding on where to invest.
For more on how you should invest, take a look at our article that explains how to create your own investing strategy.
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Disclaimer: MoneyMagpie is not a licensed financial advisor and therefore information found here including opinions, commentary, suggestions or strategies are for informational, entertainment or educational purposes only. This should not be considered as financial advice. Anyone thinking of investing should conduct their own due diligence.
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