6 Things Investors Should Know About the October Effect

October is a month of falling leaves and ghoulish costumes. But it is also a month of falling stock prices and terrifying investment returns? Perhaps so, if you believe in something called the "October Effect."

Some investors are known to get skittish this time of year, because many of the worst stock market crashes have taken place in October. But is this nothing more than coincidence? What should investors look for in October?

1. What Is the October Effect?

The October Effect refers to the notion that bad things happen to the stock market in October. In 1929, the Great Depression was preceded by several historically bad days in the market, all taking place in October. The Black Monday crash of 1987, in which the market dropped 22%, took place on October 19. On Oct. 9, 2002, the market hit a five-year low point. And the market dropped 16% in October of 2008, the start of the Great Recession.

2. Is the October Effect a Real Thing?

There's no evidence that these big market crashes took place in October for any other reason other than coincidence. There may be enough investors who believe in it to cause a sell-off, thus making it a kind of self-fulfilling prophecy, but the evidence suggests that more often than not, you'll make money in October.

According to a new report from Yardeni Research, the average monthly return in October is 0.4%. That's not a massive return, but there were 51 years of positive returns versus 36 years with down markets. It's worth noting that when the market goes down in October, it goes down hard, to the tune of 4.7%. But that's offset by good months that average a 4.1% gain. In other words, history shows that October could swing big in either direction.

3. If October Isn't the Worst Month, What Is?

October's next door neighbor, September, is actually statistically the worst month for investors. Yardeni reports that September has had 47 down months compared to 39 up months since 1928. On average, investors lose 1% in September.

4. Believe in the Market

The stock market is hard to predict. But there's one thing that has been reliably true, and that's the fact that the market goes up over time. If you have a long investment horizon, don't get caught up in worrying about the performance of a single month. And if your investment horizon is shorter, you should be invested conservatively enough (heavy on cash and bonds, light on stocks) that a single month of bad returns won't hurt you that much.

5. Don't Miss Out on December

If you sell off in October because you fear a drop, you may miss out on big gains later. December is typically a good month for the stock market, with positive returns two-thirds of the time since 1928. On average, the market in December goes up 1.4%. If you exit the market in October and don't jump back in, you'll miss out.

6. Exploit the Fear, Look for Bargains

If indeed the market goes down in October, take time to examine whether it's the result of bad company fundamentals or simply the psychology of investors. If there's a sell-off simply because people fear October, then it may be possible to find some solid stocks at a good value.

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