When a fund no longer fits, kick it out of your portfolio

Your Funds

Dollars & Sense

September 01, 2002|By CHARLES JAFFE

YONA is a 90-year-old Kansas City woman who doesn't like one of her mutual funds.

She bought the fund decades ago and counted on it mostly to produce a steady annual payout of dividend and capital gains income. The fund did that for years.

But it also changed over time, becoming a large-company growth fund, moving from regular distributions to the standard once-a-year payouts that most stock funds now provide. In the past few years, with the stock market in the tank, the fund not only lost money - about 20 percent - but it also stopped making any gains distributions.

"I'd like to liquidate the fund," Yona wrote me recently, "but I would take a loss, so I am just keeping a watch on its performance."

In this regard, Yona - who asked in a follow-up discussion that I not use her full name - is like a lot of investors, ready to bail out of a fund but reluctant to do so because of perceived losses.

No one likes losses. But hanging onto a fund you've identified as a dog specifically to avoid a loss is dumb.

If a fund is no longer right for you or if you have lost faith in management, there's no reason to hang on. That doesn't mean people should dump any fund that has a loss - that would lead to an unbalanced, nondiversified portfolio of yesterday's winners - just that aversion to losses should not be a reason to hang on.

Think about it: Yona doesn't want to lock in a loss, but holding the fund risks losing more (especially if large-cap growth funds cannot sustain their recent rally).

"It may not come back for some time," she says, "and without what I have left, I won't have much of a future."

She wants to see the fund make a big payout at the end of the year - something that is unlikely in most large-growth funds, given the losses they have endured since 2000 - but what she would really prefer is a more conservative income fund.

Yona acknowledges that the fund - and I'm not naming it because it is the investment process rather than the specific fund that matters here - was good to her for a long time. When pushed, however, she recognizes that a stock fund that grew well over the past 40 years may not be the right place for 25 percent of her money this late in life.

"People don't like to take losses because it does nothing for their self-esteem except hurt it," says Richard Geist, who publishes the Strategic Investing newsletter and is the founder of the Institute of Psychology on Investing in Cambridge. "The problem is complicated in an older person - who is probably particularly concerned about current losses - and with anyone who has held a fund for a long time, so that the fund feels like a part of them."

Most fund specialists believe there are a number of good reasons to sell a fund. They include:

You have reached your goals, or soon will.

You need to change your asset allocation.

The fund changes strategies or missions.

The fund changes managers - particularly a manager whose presence inspired you to invest in the first place - or grows enormous quickly.

You have a loss and want to capture tax benefits from it.

You wouldn't buy the fund again today and/or you have lost faith in management's ability to help you reach your goals.

In Yona's case, four of those six reasons to sell are in place.

The fund has changed over the many years she has owned it, plus its investment style - appropriate for the vast majority of investors - is not particularly right for a 90-year-old more interested in protecting assets than increasing them. Yona needs an asset-allocation change; she is wishing her growth fund would act more like a bond or certificate of deposit.

Finally, her lost faith in the fund's management is obvious from her letter.

In fact, when she wrote the words "I would like to liquidate," she should have taken that as a sign that it was time to part company with the fund.

Says Geist: "If you can write that line about a fund, it says all you need to know. It just doesn't take into account the psychological factors that keep you in it."

Generally, those factors become excuses like "It was good to me once," "It can't stay this bad forever," or "I'm waiting to get back to break even."

Those are not reasons to stay with a bad fund. Neither is avoiding the admission of past mistakes.

If all you have is an alibi for holding onto a fund - rather than a concrete investment-driven reason - give yourself some peace of mind and make the change that your situation calls for.

Charles 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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