Mentally sell everything, then decide what you'd buy

Your Funds

Dollars & Sense

February 03, 2002|By CHARLES JAFFE

MOST INVESTORS buy mutual funds that inspire high hopes and expectations. Unfortunately, they tend to hold funds that don't live up to those dreams.

Symptoms include hanging onto funds hoping to get back to break-even and a willingness to shrug off long losing streaks rather than risk picking a new issue.

Indeed, fund ownership can be an impediment to change, an excuse to lower your standards rather than acknowledge potential problems. It's like overlooking food stains on the upholstery of your current car, when you wouldn't accept such a mess in a vehicle you're about to buy.

One way to rid yourself of this ownership malaise is to sell everything. That's not a recommendation to dump all your funds, but rather to bring a buyer's critical eye to the annual performance review you do with those year-end statements.

People in the market for a fund look at more than its 12 months of performance and its ranking within its peer group. Buyers also consider everything from how a fund meets current needs, to where it fits in with overall investment strategy, to how it is rated and how they expect it to perform.

The mental exercise of selling and then rebuilding your portfolio - actual selling has tax consequences that we'll discuss in a moment - forces you to answer the key question "would I buy this again today?" while examining your portfolio as a whole, rather than simply looking at individual items.

It also helps you get over the wall that stops many people from selling, namely reluctance to admit a mistake. Revisiting your purchase decision - rather than simply looking at recent performance data - may show that you would no longer buy a fund. You may have liked it once for its star rating, its low minimum investment or its investment strategy; all of those factors could have changed, or at least lessened in their importance to you, over time.

If you come to the conclusion that you wouldn't buy a fund again today, a change might do you good.

Here's how to conduct a sell-everything evaluation:

Start by hypothetically selling everything, figuring out the amount of cash you'd generate by dumping all of your investment holdings.

Next, determine what funds you would want - shop around as if you are in the market for new funds - and how you would like to allocate your assets. If, for example, the bear market has made you more conservative and interested in bonds, make sure your dream portfolio provides sufficient fixed-income investments.

The next step involves comparing your ideal funds/allocation with what you actually have right now.

If your ideal funds overlap with your current holdings, decide whether - given your druthers - you'd go with the current position or take a shot with something new. Look, too, at how you have to rebalance your investment portfolio to move into your preferred asset mix.

The result should be an ideal, but still imaginary, fund portfolio.

This is where we go from hypothetical to reality.

Wherever your ideal portfolio doesn't match your actual holdings, take a closer look.

That brings us to the hardest part of this start-over exercise, dealing with the problems that become clearly visible once you see that your portfolio falls short of your ideals.

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.

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 and investment strategy or is just vastly superior to what you own.

Determine your gains in the fund (many firms include your average cost per share on their statements) and figure that you will lose one-fifth of any long-term profit to Uncle Sam and his little brothers (your state tax collectors). If you don't believe that your ideal funds can outperform your current funds by enough to quickly recoup the tax bill incurred in a sale, chances are you should stick with your less-than-ideal current funds.

You may decide, however, not to add more money to your current fund, directing all new investments to funds that you want to beef up and rebalancing your portfolio to your ideal asset mix in the process.

The result of a sell-everything evaluation, rather than a simple annual performance review, is that you'll be left with a road map showing where you are, where you want to go and what path makes the most sense to follow.

In the end, this map should lead you to a portfolio that you are as excited to hold as you were in the first place.

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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