Five good reasons for dumping a fund
Now that the stock market is picking up, people are once again looking at mutual funds as a way to build wealth. While advice on buying funds is plentiful, advice on selling is not. Although there are good reasons to sell a fund, experts say, a recent slide in performance is not one of them.
"The worst reason to sell a fund is because its performance was poor," says Emily Hall, a senior mutual fund analyst at Morningstar Inc., in Chicago. Mutual funds are geared toward long-term results, Ms. Hall maintains, so if a fund performs poorly for a few months to a year, that's not automatically a reason to unload it.
"Negative returns, particularly short-term negative returns, in and of themselves, are not always a reason to sell a fund," she says.
"Clearly, one of the mistakes investors make is buying whatever mutual fund did well last year," agrees Nathan Gendelman, investment strategist for The Family Firm Inc., a financial-planning company in Bethesda, Md. "The other is overtrading," that is, buying and selling funds too frequently, he says. "It's exactly the wrong strategy to employ."
Mr. Gendelman also warns against treating mutual funds and stocks in the same fashion. "People will buy a fund designed to capture an [entire] asset class, yet they'll execute trading strategies with the mutual fund as if it were a single stock."
For example, one school of thought holds that if a stock declines by a certain percentage, it should be sold, because the decline might indicate an underlying difficulty of the company. If a mutual fund declines, however, it could be the result of an entire asset class - international stocks, for example - falling out of favor. As asset classes regularly go in and out of favor, this could indicate a bargain, Gendelman says, not a sell signal.
"The worst decisions investors make is to sell what is out of favor, and buy that which is in favor. It is exactly the opposite of what I am convinced will lead to higher return," says Paul Merriman, president of Merriman Capital Management in Seattle.
People should decide what would cause them to sell a fund before they buy into it, Hall says. This can help investors avoid snap sell decisions that could hurt them in the long run.
Among the reasons Hall and other experts list for possibly selling a fund:
• A sudden jump in expenses. Investors need to keep an eye on whether their fund's expenses are in line with similar funds.
Even though a fund's expenses may be competitive when you buy it, expenses can change, Gendelman points out, particularly if the fund has been bought by another company. You might be able to save money by replacing a fund with high expenses with a lower-cost fund following a similar objective.
• A new fund manager. A fund's terrific performance might be dependent on an extremely competent, high-profile manager. A new manager may not change the fund's portfolio immediately. Even though semiannual or annual reports often paint changes in glowing terms, so you might want to keep a close eye on the fund. Check with mutual-fund services such as Morningstar to follow news about the fund.
• A change in investment philosophy or direction. After buying a fund that matches your risk tolerance and fits into your asset allocation plan, you need to make sure that it continues to do so. If the fund had been conservatively managed, but the fund manager suddenly favors riskier ventures, it may be time to pull out.
• Low tax efficiency. Tax efficiency is the fund's ability to provide returns while avoiding capital-gains taxes. In many cases, tax efficiency is a function of turnover, or, how often the manager buys and sells stocks in the fund's portfolio. Check with your tax adviser if you have any questions.
• Rebalancing your portfolio. This can be a hard decision, because it may require you to sell some shares of your better-performing funds, and put that money in funds that have not performed as well recently, though they may have good long-term records. Rather than selling the fund entirely, however, just trim enough shares to keep the portfolio balanced across the asset classes you originally chose.