Reasons to give a fund the boot

Your Funds

Your Money

August 28, 2005|By CHARLES JAFFE

THE SPEAKER was ripping mutual funds, as part of a spiel that he hoped would sell a stock-trading investment-education program. The best you can expect from funds, he said, is that they will go sideways.

Most people in the room at the Westin Hotel in Waltham, Mass., agreed.

And then the instructor - who was espousing the values of trading stocks - made his only remark about funds all night that made any sense: "Why would anybody stick with funds when they aren't getting anything good from them?"

The average fund does not lose money or move sideways over time. A disappointed investor might buy that hype, but it's not backed up by numbers.

Still, plenty of investors are disappointed with their funds' performance, and there is no denying the thousands of mediocre funds out there.

Because the fund world isn't a meritocracy, where only the best survive, investors disappointed in the issues they own must also be upset with themselves. After all, they have stayed in a fund even after doubting its ability to perform.

Knowing why you should sell a fund is every bit as important as knowing what to buy.

Most people sell funds for just one reason, poor performance. But fund firms often are rewarded for mediocre results by investors who stick around hoping things will get better.

That's how the guy running the seminar can talk about fund investors moving sideways.

Having a sell discipline is crucial for investors, because the aim is not just to post gains but to avoid years of neutral, lackluster results.

If you are wondering whether your funds are worth hanging onto, consider the following:

How has the fund done compared to its peers? Losses - or unexpectedly slow returns - are the biggest concern for investors, but a loser may be at the top of an ailing asset class.

As the stock market peaked in 2000, it would have been hard to find a real estate fund that was doing particularly well; when the market turned, however, the real estate funds took off. The investor who bailed when the funds were down missed out on the benefits of diversification.

If poor returns make you realize that the asset class is wrong for you, dump the shares in favor of something completely different. It makes no sense to stay in an investment category you can't stomach. But if you have a long-term outlook, compare the fund with its peers to see whether it's a laggard.

Experts differ on how long to give a fund consistently lagging behind its pack, but waiting forever is a mistake; management owes you a chance at good performance, and if they can't deliver for, say, two years, they deserve to see you leave.

Has the fund changed strategies or missions? This happens less now than in years past, but if a fund stops buying the things you bought it for - maybe it has grown and is now investing in mid- or large-cap stocks instead of small ones - you may want to look for the exit.

Some fund managers make subtle changes, over-tilting their portfolio toward hot sectors. Others ask investors for permission to buy riskier investments or to move into new asset categories. By keeping an eye on the portfolio, the fund's paperwork and the category that the ratings agencies apply, it's easy to see if things have moved away from what you thought you were buying.

Has management changed? A manager change should make you anxious, but there are plenty of cases where a star manager has left and the fund has barely missed a beat.

Still, if performance declines after a change - or if you are hoping a new manager will get things back on track and you don't see improvement - it's a reason for concern.

Your worries should also include the sale of the fund management company. Mergers typically enhance research power, but there can be friction if a fund does not fit in with the new parent company's style, or if your issue is about to be merged into something else, a move that might alter the fund's objective.

Have you reached your goals, or will you soon? If you buy a fund for a reason - to finance 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 availability when needed. Don't reach the target and then borrow money - from, say, a 401(k) or on credit - to avoid cashing in.

Would you buy the fund again today? If a fund can't meet the same criteria applied when you bought it - and no longer looks so attractive - start shopping.

Charles Jaffe is senior columnist for MarketWatch. He can be reached at jaffe@marketwatch.com or at Box 70, Cohasset, MA 02025-0070.

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