Consider selling everything, then whether you'd buy it again

Your Funds

Dollars & Sense

January 02, 2000|By Charles Jaffe

LAST WEEK, I got e-mail from a reader who was planning to sell out of all his funds just before the year ended. He wanted to know if I thought this was a good idea.

Sell everything?

You bet it's a good idea, I told him, so long as it is an exercise of the imagination.

I find that one of the most effective ways to evaluate holdings is to start over, mentally getting rid of what you have in order to pick a new portfolio based on what you know today.

It's a particularly good exercise to consider now.

The release of year-end numbers [see today's year-end mutual fund tables] will give many investors a good reason to review the performance of their funds.

Unfortunately, most portfolio evaluations are based on low standards, relying almost exclusively on returns as a gauge of whether a fund is worth holding.

Ownership becomes an excuse for lowering standards. Just think of how many people hold money-losing investments waiting for a return to break-even when, undoubtedly, break-even was not their goal when they first bought in.

By comparison, people shopping for new investments look at a wider array of issues, ranging from how well a fund meets needs to where it fits in with their overall investment strategy and how they expect it to perform in the future.

That's why the ultimate test of your mutual fund portfolio involves selling everything, then figuring out how to build a portfolio with the proceeds. The mental exercise of selling -- actual selling has tax consequences that we'll discuss in a moment -- also ensures that you don't just examine your funds one at a time, but as a unit.

The sell-everything test forces you to answer the question "Would I buy this again today?"

It's often harder to bring yourself to sell a fund than it was to select the fund in the first place. Revisiting the purchase decision may show that there is nothing wrong with the performance of your funds. It may show that you wouldn't buy them based on your current needs, desires and attitudes.

No matter the reason, if you wouldn't buy some of your funds again today it's a sign that a change might do you good.

Here's how the sell-everything test works:

"Sell" everything today. Figure out how much cash you'd have if you unloaded everything.

Next, determine what funds you would want -- and how much you'd invest in each -- if you were building a new portfolio from scratch.

Consider funds you own and funds you wish you owned. Re-examine everything, from your asset allocation (i.e., has the growth of tech stocks left you overweighted there?) to overlap (two funds that buy the same kinds of stocks).

The result should be an ideal-but-imaginary fund portfolio.

Compare that imaginary portfolio with your real one and, wherever things don't match, get out your magnifying glass for a closer look.

That brings us to the hard part of this start-over exercise, namely the problems that become plainly visible when you see that your own portfolio is not your "ideal" portfolio.

If your investments are in tax-deferred accounts, you can sell anything or everything and not worry about paying taxes on your gains.

If the funds are in taxable accounts, however, the tax bill for a portfolio overhaul could be overwhelming.

In fact, it's not worth changing one fund for another unless the new offering -- the one in your imaginary portfolio in this drill -- is part of a shift in asset allocation-investment strategy or is just vastly superior to what you own now.

Size up the tax hit-opportunity cost of switching funds by figuring out the dollar amount of your profits.

Many fund companies include on their statements the average price-per-share you paid; just subtract this amount from the current price and multiply the result by the number of shares you own.

That result is the amount of your holdings subject to capital gains tax if you sell. Expect to lose at least one-fifth of that amount to Uncle Sam and his little brothers (your state tax collectors).

Simply put, if you don't believe your ideal funds can quickly recoup the tax burden incurred in a sale, you may be better off sticking with your less-than-ideal current holdings.

If your ideal portfolio has a different asset allocation than you have now, you may avoid selling simply by directing all new investments to the funds you want to beef up.

This will, in time, rebalance the portfolio.

The result of this exercise is a road map that shows where you are, where you want to get to, and the path that makes the most sense.

And, if you have picked your funds well, by "selling everything now" you may learn that the best course of action is actually to sell nothing at all.

Charles A. Jaffe is mutual funds columnist at the Boston Globe. He can be reached by e-mail at jaffe@globe.com or at the Boston Globe, Box 2378, Boston, Mass. 02107-2378.

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