Deciding When to Sell a Mutual Fund

The following is an excerpt from Personal Investing: The Missing Manual.

If a fund is performing badly, investors are prone to making one of two mistakes. Some sell in a panic, while others hold onto the fund hoping it will turn things around. Most funds give a few warning signs before they crash. If you learn to spot those warnings, you can review a fund that looks like it might be headed for trouble, make an educated decision about selling, and possibly sell before the fund hits the skids. Here are fund red flags to watch for:

• Departing manager. If you own an actively managed fund, the fund manager delivers the fund performance. If the longtime manager is leaving, but co-managers or the management team is staying in place, don't sell just yet. If brand-new managers are coming in, check out their track record to see if their experience is on par with the old manager's reputation. If it isn't, consider replacing the fund.

• Proposed fund merger. Fund companies get rid of their dogs by merging those funds into other funds. If you learn that your fund is merging with another, evaluate the new fund as you would a brand-new fund purchase to make sure it's right for you.

• Changing investment strategy. Review your funds' investment objectives and the securities in their portfolios. If you notice that a fund has started to invest differently by, for example, buying large-cap stocks instead of mid-cap stocks, you may want to replace the fund with one that fits your financial plan.

• Big increase in assets. Really successful funds rake in oodles of new money. That's not necessarily good for future performance, because the fund managers may have a hard time investing all that cash. Small and mid-cap stock funds are especially vulnerable, because it's hard to find enough suitable investments to deliver the same kinds of returns they've produced in the past. If the fund management closes the fund to new investors, don't sell. They're watching out for your best interests by keeping the fund at a manageable size. If the fund continues to accept new investments, watch the fund's performance closely, and get out if it starts to falter.

• Bad long-term performance. Don't sell a fund because of poor performance for a short period like 3, 6, or 12 months. The fund may do better in up markets or down markets, or may have gotten temporarily derailed. But if performance falls behind the comparable market index and the competition year after year, look for a replacement.

• New or higher fees. Higher fees take money away from your investment returns, so they're never good. But, if the amount's small (less than 0.1%) and the fund is doing well, it's usually worth staying put. If a fund makes large increases in fees or increases its fees regularly, start looking for a new one.

• Turmoil. If a fund family is bought or sold or a star manager leaves (taking staff with him), that chaos can distract fund managers from their jobs and drag returns down.

• Rising turnover rate. If the turnover rate increases and stays at higher levels, your expenses and tax bill are likely to climb as well.

Tip: Never trade in a fund based on a hot tip you heard around the water cooler at work, at the gym, or from your landscaper. Don't automatically replace funds just because your broker gives you a suggestion. Always do your homework first.

Even if red flags aren't waving, you may decide to sell for other reasons:

• You need the money. Selling a fund because you need the money for something is perfectly OK. That's why you invest in the first place.

• Balance your portfolio. When you review your portfolio and find that your asset allocation is slightly out of balance, you should sell fund shares in the areas that are over-allocated and buy more in the areas that are under-allocated.

• Changing goals. If your life changes, so will your goals. If your child earns a big honking scholarship, you can look at reinvesting the college savings you've amassed into something else.

• Sleep. If you're losing sleep over your investments' performance, it's time to make some changes. Ratchet down the risk until you sleep comfortably at night.

• Taxes. If you sell a fund that generates capital gains, you may decide to sell a fund with losses to offset the gains.

Tip: You can find out how much you'll pay in taxes and fees when you sell by running your fund numbers through AOL's Wallet Pop "Should I sell my funds now and invest the money elsewhere?" calculator (http://tinyurl.com/yl8bn7s).

Comments

[Old Limey]

While some of the changes made by a mutual fund may turn out to have a negative impact upon performance they are not a signal to immediately sell the fund.
There are three good reasons to sell a fund - they are PERFORMANCE, PERFORMANCE and PERFORMANCE.
Since the #1 rule for success in investing is: "Don't lose money", the most idiotic statement in this article is:

"Bad long-term performance. Don't sell a fund because of poor performance for a short period like 3, 6, or 12 months".

Once any investment is acting poorly and/or its asset class is in a downtrend you need to watch it closely and make a decision fairly fast or, before you know it, your profits are disappearing or you have a large loss. It doesn't matter about it's long term record, what matters is what it is doing now.

Assuming that you have the means to analyze and compare the performance of hundreds, if not several thousand, mutual funds, as soon as one of your holdings is underperforming its asset class, or the whole asset class is being dragged down for some good reasons, you have to get to work and find a replacement ASAP. If you cannot find an investment that is in a nice, low volatility uptrend, then sit on the sidelines and continue to monitor the funds that are available to you until you can.

If you don't have the means to analyze the performance of hundreds, if not thousands of mutual funds then you need to obtain help.

As shown in the following table, I started managing my investments on 12/28/92 and have not had a losing year since. The table is sorted by "Maximum Drawdown".
UI% is the Ulcer Index, a measure of volatility.
ANN% is the annual compound rate of return.
UPI is the Ulcer Performance Index, a measure of the risk adjusted rate of return.
MDD% is the percentage Maximum Drawdown and the date it took place.
As you can see, over this 18 year, 8 month period my worst drawdown was 15.90% whereas the Buy and Hold drawdown for the market indexes ranged between 54% and 78%. Some readers may know what it feels like to experience a 54% drawdown. There is no way I could suffer through such a drawdown especially when at the time of that huge loss you have no idea what the future holds.

.....................................UI%........ANN%........UPI.........MDD% and DATE.........START............END
Old Limey...................4.57.........18.45........2.85.........-15.90 .....03/25/00..........12/28/92....08/25/10
Dow 30....................14.05...........7.60........0.16..........-53.78.......03/09/09..........09/01/88 ....08/25/10
S&P500...................18.57...........6.61........0.06..........-56.78......03/09/09..........09/01/88....08/25/10
Nasdaq....................40.59...........8.27........0.07..........-77.93.......10/09/02..........09/01/88.... 08/25/10