Of The Month –August,  2009

Should You sell- Get Out Of Your   Mutual Fund?

Clearly, one of the mistakes investors make is buying whatever mutual fund that did well in the last 3 months, one year.  Should you sell – get out?  You have to go back to the beginning --- You should decide what would cause you to sell a fund before you buy into it.  This will help you to avoid quick “sell” decisions that could hurt you in the long run.

A survey by Boston based Eaton Vance Management states that “only about one in four investors has ever redeemed or sold a fund because of poor performance.

Its not that you should never trash a fund but there are some questions you should ask before you do.  There is no one magic formula but there are some things you should consider when making your decision.

Rule#1:  Have a good reason to get out.

1.       The fund consistently has poor performance.  One poor quarter of performance does not indicate you have a bad fund; even one year.  Some experts say you should look at the record over several different periods before selling.  Some say that if a fund has under performed its peer group average (benchmarking) by two points in 3 years or 3 points in 5 years, it may be time to sell.  Another expert says you should get out if your fund has under performed similar portfolios for three years.  Compare your fund’s performance with similar funds, the average of fund’s  with the same investment objective, and indexes (S&P 500, Wilshire 5.000, etc).  Make sure you measure its returns carefully, check benchmarks.  You can call your fund and ask for the appropriate benchmark.  One thing to consider is that it may be the investment style rather than the fund that is temporarily out of favor.  Just about everybody’s advice is: sell when performance lags.  Some say it is time to look for alternatives when it lags for 4 straight quarters.  Your fund should rank consistently in the top half of its group.

2.       The style of the fund has changed.  Make sure you are getting what you signed on for when you purchased in to the fund.  In some cases, a fund may find that its usual strategy isn’t working and it may shift to a more trendy approach.  Sometimes a fund may get flooded with assets and begin to increase the size of the typical companies in which the invest.  You can check with a mutual fund rating service like Morningstar to see if a fund is changing its investment philosophy.

3.       The funds new manager fails to make the grade.  One expert says, “Fund management is a people business and the person or group managing is key.”  Some experts say you should seriously consider getting out when a fund changes its manager.  Some feel that is too hasty and that you should look at its performance a little more closely.  You don’t have to assume that the new manager will fail.  One expert suggests that you dump the fund if it lags its peers by at least 3 percentage points over 18 months.  A change in manager doesn’t mean you should opt out immediately.

4.       Problems within the fund.  If other investors are bailing out in droves, that is usually a symptom of serious problems at the fund.  This can happen when a star manager leaves the fund.  In some cases, shareholders are hit with losses when he/she leaves in order to meet redemptions caused by the departure.

5.       Sell to make up for a mistake.  You may have purchased a fund because it qualified under your original guidelines or criteria.  But, unaccountably it may fail to live up to your expectations.  Some experts say that you shouldn’t hold on too long just to see that it would.  Investing is an imperfect science.

6.                 It isn’t tax efficient.  Some investors remember the pain of 2000---a year when many funds passed along significant capital-gain hits.  If you are consistently losing big chunks of your gains to Uncle Sam, you might want to get out of funds that generate big tax bills and into tax-efficient alternatives, which use tactics like low portfolio turnover to create less tax liability for their shareholders.  Alternatively, be sure to hold funds that aren’t tax efficient in tax-exempt accounts like an IRA.

7.                 It keeps you up at night.  Mutual funds are not supposed to have you tossing and turning and losing sleep at night.  Christine Benz, editor of Morningstar’s Fund Investor newsletter states, “You need to ask yourself, are you compatible with this fund.  If this is a gut-wrenching time for you, then the fund might be too volatile.”

8.                 Review your portfolio of funds.  Every year take a look at what you have.  As you review your holdings, ask yourself this question-- “If I didn’t already own this fund, would I place an order and buy it today?”  If the answer is no and the reason is because of your goals, risk tolerance or other personal circumstances have changed, you have a strong sell candidate.

9.     A sudden jump in expenses.  You need to keep an eye on whether the fund’s expenses are in line with similar funds.  Even though the fund’s expenses may be competitive when you bought it, expenses change.

10.                         Rebalancing you 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.

The advice that professionals give is “buy and hold” but it is not “buy and hold forever.”  Don’t be too quick to sell but don’t fall in love with it forever, either.  Don’t be afraid to admit defeat.