- The Washington Times - Wednesday, May 12, 2004

When your home or car no longer suits your lifestyle, it’s usually pretty obvious. But knowing when to sell a mutual fund that no longer fits your portfolio can be more difficult.

For most investors, buying shares of a mutual fund, a stock or a bond is a big deal, so it makes sense to research the options. Investors are rarely so analytical when it comes to selling, however, and sometimes just never get around to it. But if you are focused solely on the accumulation of shares, you might wind up with a disorganized portfolio, and that can cut into your overall return.

“The selling process is emotional and psychological. People can feel very attached to funds and stocks,” said Vernon Lee of Lee Investment Consulting in Raleigh, N.C. “Sometimes people end up with portfolios that don’t make sense at all; it’s just a hodgepodge of stocks, and they need to prune it.”

Inexperienced investors often collect mutual funds that overlap, Mr. Lee said. For example, investors might think their portfolios are diversified because they own several different funds, but they are oblivious to the fact that the funds are all growth-oriented with many of the same holdings. Others like to snap up shares of funds when they hear pundits talking about them, but are reluctant to sell at a loss when they underperform.

If you are wondering whether your portfolio needs some trimming, there are a few questions you can ask yourself. Start with why you bought the funds.

“If you were looking for a fund to fill a specific niche in your portfolio, and it’s not living up to what you thought it would be, that might be a reason to consider selling,” said Christine Benz, associate director of fund analysis at Morningstar Inc.

If a fund has changed significantly while you’ve owned it, you need to make sure it still fits in with the rest of your investments. A shift in sector focus or style isn’t always a signal to sell, however. Many of the best managers seek opportunistic values among beaten-down stocks, which means their portfolios will change with the market cycle. But if the manager seems to be veering from the true spirit of the fund, that could be cause for concern.

Whether the fund has changed or you misunderstood its fundamentals in the first place, you should evaluate its performance against an appropriate benchmark, usually a stock market index, before you decide to sell. Look for striking deviations, both positive and negative. If your fund has dramatically outperformed its benchmark, that could be a warning that the manager is taking on too much risk.

One effect of the bear market is that it gave investors an idea of how different funds will behave in a variety of economic climates. If a fund has not distinguished itself in any type of market, it might be time to cut your losses. Or perhaps you’ve learned that you are less open to risk than you thought.

“It’s never too late to sell because of volatility,” Ms. Benz said. “People have a tendency to want to hang on and try to break even. … If you bought a tech fund in ‘99 or 2000, and the losses you incurred during the bear market were just gut-wrenching, it’s OK to sell.”

And then there’s the market-timing scandal: If the company running your fund has been fined for tolerating improper trading practices that cut into the returns of small investors, you might decide to take your business elsewhere.

Many of the companies involved in the case have been associated with other types of shareholder unfriendliness as well — such as rolling out gimmicky funds and charging extremely high management fees.

But the most compelling reasons to sell are often more personal, said Mr. Lee, the consultant in North Carolina.

“Probably the biggest reason why you should sell has to do with the overall big picture,” said Mr. Lee. “If your goals have changed … or your lifestyle has changed somehow, that’s always a reason to take a closer look at your portfolio.”


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