Don't sell just because the price may be down

Your Funds

Dollars & Sense

March 25, 2001|By CHARLES JAFFE

"I BOUGHT Janus Twenty for $80 per share in January 2000," the letter began. "Today, my shares are worth $42. I'm ready to sell when the fund hits $40. What do you think?"

I think it's a bad idea.

That's not an endorsement of Janus Twenty, whose volatility makes it inappropriate for some investors and whose recent performance is discouraging. It's simply that you never unload any fund based exclusively on movement in its share price.

The investor who wrote that unsigned e-mail was looking to apply a stock trading technique known as a stop-loss to a mutual fund investment. Bailing out based entirely on a fund's current price or recent performance is something a lot of investors are considering these days, but that doesn't make it right.

If the thought has crossed your mind to set a price limit at which to dump a fund, you are applying stock investment strategy to funds, a move almost certain to end in a mistake.

With stocks, a stop-loss order is the price point, preset by the customer, that triggers a sale, thereby protecting profits or stemming the tide of losses when the specific issue takes a downturn. It can be a good strategy in a stock portfolio, in part because stock prices are based on investor sentiment.(That's why dot-com stocks skyrocketed. Investors looked at profit potential rather than the balance sheet and valued the stocks at more than they were worth; once investors started looking at profit statements, the shares plummeted.) But funds don't work like stocks.

A fund's share price represents the current value of its underlying portfolio. There's no sentiment there, just the value of the holdings divided by the number of outstanding shares. (What's more, a fund's price declines by the amount of dividends and capital gains it distributes; investors who reinvest those payouts but make sell decisions based on price might not factor the effect of distributions and sell too early.) Furthermore, a fund plays a different role in a portfolio than a stock does. To build a diversified portfolio of stocks, you could hold anywhere from dozens to hundreds of individual issues, covering various industries and asset types. Dropping one stock does not necessarily change your asset allocation.

A fund portfolio, by comparison, should have a few funds, each representing an entire segment of the market. If the writer drops Janus Twenty and has no other large-cap growth fund, the resulting portfolio has a hole in a key part of the market.

"We choose mutual funds to fill a need in a portfolio," says Daniel P. Weiner, editor of the Independent Advisor for Vanguard Investors newsletter. "That's why a stop-loss doesn't get at the real issue. It's not `How much did I lose in this fund?' It's `Is my whole portfolio down too much?' or `Did I put too much ... in this one sector?' "

Adds Stephen M. Savage of the No-Load Fund Analyst newsletter: "Assuming you had valid reasons for having exposure to a type of fund in the first place, you need to assess whether your long-term thinking is still valid. Stop-loss doesn't do that, because it just looks at the current price and not the relative performance of the fund."

Janus Twenty has a rating of 4 from Morningstar Inc., placing it in the upper echelon (5 being the highest) of large-cap growth funds. While its recent performance is disappointing, Janus Twenty's downturn is in lock-step with most of its large-growth peers.

Experts confronted with the stop-loss question fear that investors dumping the fund now would replace it with a fund that has been hot recently. Just as they may have chased performance getting in - as the e-mailer bought Janus Twenty last year after a great run-up of gains - they might compound the problem by going into today's hot sector just before it cools off.

"It's wrong to think dollars or share price first. You have to think strategy first," says Roy Weitz, who runs the FundAlarm.com Web site, which advises investors on when to sell funds. "If you believed in your allocation before, nothing should have changed now. If you are ready to bail out entirely based on the fund's current price, it says that you don't really have faith in either your portfolio and investment strategy, your asset allocation or the specific fund." That said, virtually all experts agree that a mental stop-loss, set before you buy a fund as the point at which you revisit both the fund selection and your overall strategy, makes sense.

"There does come a point where you say, `That's it, I can't take any more,' but that's something you set up when you buy a fund," says Thurman L. Smith, publisher of Equity Fund Outlook. "Once you own a fund, don't sell because the price has gone down.

"Sell because you no longer believe the fund is good compared to peers, you no longer believe in the segment of the market it represents, or you think you made an asset allocation mistake. Don't sell just because the share price is down."

Chuck 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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