Conditions to consider before dumping fund

Your Funds

May 12, 2002|By CHARLES JAFFE

THERE ARE a lot of reasons to get rid of a mutual fund, but only one ever seems to persuade investors to pull the ripcord: performance.

Last month, just as investors started to get hopeful that the long market decline was easing, a string of negative announcements about earnings and revenues sent the market tumbling again. Watching meager gains from the past six months evaporate in the span of a few weeks has some investors ready to throw up their hands.

In most instances, it's the wrong move.

Just as outstanding past performance shouldn't be the sole reason to buy a fund, losses alone shouldn't prompt a diversified investor to sell.

Bailing out of a loser without examining broader ramifications leads to buying whatever looks profitable now, which is precisely how to buy high and sell low. (Many investors dissatisfied with a current holding did just that, investing with a hot fund and being surprised by losses when market conditions changed.) Knowing when and why to sell a fund is a decision at least as important as knowing what to look for when buying.

In general, a sell decision should be triggered by a few conditions. If you see two or more of the following conditions in a fund you own, it might be time for a change:

The fund has changed strategies, missions or managers.

You buy a fund to put a certain type of asset to work for you, such as growth stocks or international investments. If the fund stops buying the stuff you want, it could be time to look for the exit. This can also be a size issue; some funds, particularly small- and micro-cap funds, tend to change as their assets grow.

If your fund seemed to thrive once and is stumbling now, consider whether something or someone at the fund has caused the change. If the only difference is today's market conditions, be careful not to overreact.

Poor performance relative to similar funds.

Don't ignore performance, just look at it in context: A losing fund might be at the top of an ailing asset class, a condition many investors could find in their large-cap growth funds right now.

If a fund is losing money and consistently lagging behind its peers, it's time to get nervous.

If the poor returns make you realize that the asset class is wrong for you - such as a risk-averse investor holding high-yield (junk bond) funds - dump the shares in favor of something completely different that changes your asset allocation. Otherwise, don't alter your investment strategy - which buying a new fund with better recent results most likely would do - based on current performance alone.

You've reached your goals - or will soon.

Sell if you bought the fund for a reason (to fund college or retirement or pay for a car) and have reached the goal. Use the money for its purpose, or get conservative with it to ensure its available when needed. Don't reach the target and then borrow money from a credit card or your 401(k) to avoid cashing in.

You need to change your asset allocation.

Over the years, your portfolio should shift, usually becoming more conservative as you age. At times, changing your asset allocation simply means directing new funds into additional funds. Sometimes, however, it means selling off part or all of your stake in an account to redirect the money to a new asset class.

You've got a loss but want a tax refund.

There are tax benefits to selling a fund with a loss (unless you hold it in a tax-advantaged retirement account). The loss negates other capital gains you might have and can offset up to $3,000 of ordinary income. Selling a loser can be a winning tax strategy, but look for a fund from the same asset category to buy with the money, or it could mess up your investment strategy.

You wouldn't buy the fund again today.

If you bought the fund for a reason - say, it invests in the hottest market sector or cuts expenses to keep yields high - and that factor evaporates, dump the fund.

Also, you might have needed a fund with a low investment minimum when you started investing, and you no longer have that kind of restriction.

If a fund can't meet the same criteria applied when you bought it - or if your criteria have changed - start considering alternatives.

One telltale sign of a change of heart is that you have stopped making additional investments to the fund and can't see yourself starting again. This signals a loss of faith, which may be the biggest reason to sell a fund; once you are certain not only that a fund makes you uncomfortable today but also that you'll never trust it again regardless of future performance, it's time to move on.

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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