Question: Last year, I missed participating in the January Effect. I didn't know about it in time. What is your advice?

Barbara Snell

Answer:

Dear Barbara,

Just so other readers of this column will know what we're talking about, I want to give an official definition...

The January Effect is a trading philosophy based upon the hypothesis that small company stocks have a big "bounce" every year right after January 1st.

According to various studies, the January Effect has actually taken place 70% of the time since the year 1926. I feel that some of the so-called "effect" or bounce in price, might be due to the wide publicity it's received. In other words, institutional and individual investors may be buying small company stocks toward the end of the year in order to take advantage of what they've read about or heard about in the media -- the theoretical upward movement that takes place in the New Year.

Given the fact that some small stocks move up some of the time after December 31st, we need to ask why.

It has to do with taxes. Individual investors, portfolio managers and mutual fund managers for years have tended to sell their poorly performing stocks before the end of the year.

This widespread activity, of course, can further depress prices of those stocks. Then come January, investors seeking bargains, sometimes referred to as "bottom fishers," come in and buy up depressed stocks.

The immediate impact is a short-term increase in prices for this particular group of stocks.

If by your question, you're thinking of playing this strategy, please be wise. Please be cautious. Indeed, look for stocks that may be down in price but only those that have the potential for performing well long-term. Do not purchase a stock simply because it is down in price.

As you know, the philosophy here at BUYandHOLD is just that -- buy and hold. However, if you feel comfortable putting a small portion of your portfolio in more speculative choices, make certain you select stocks of companies not carrying a significant amount of debt. You've read it here before, but it bears repeating, sound management and a sound balance sheet are essential. And, both can be ingredients of small, out-of-favor companies, down in price come January 2nd.