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Course 504
When to Sell a Fund

Introduction

While most of us can agree on what to look for when buying a fund—good risk-adjusted returns, long manager tenure, and so forth.—we often part ways on when to sell. None of us want to be one of those investors who undermines his or her returns by buying and selling at the wrong times. Yet some situations almost demand that we hit the sell button.

The Fund Loses More than It Should

Suppose a bond fund loses more than 23% in a year in which its average peer suffers a much slimmer loss. That was the case with BlackRock World Income MAWIX in 1998, a multisector-bond fund that made a big bet on emerging-markets debt in general and Russian debt in particular. Shareholders who expected boring bond performance should have sold.

The Fund Gains More than It Should

This might sound illogical—after all, who complains about great returns? But if your "moderate" balanced fund posts a 60% return when its average peer is up 10%, maybe you don't own what you think you do.

The Fund Changes Its Strategy

Presumably, you buy a small-value fund because you want exposure to small-value stocks. If the manager suddenly starts buying large-growth stocks, you may have a problem. After all, you may already have a large-growth fund in your portfolio.

Be careful in how you define a change in style, though. Sometimes a manager's stocks and habits will change, even though his underlying strategy hasn't. Baron Asset BARAX is a case in point. The fund didn't migrate from the small-growth to the mid-cap growth category because manager Ron Baron began buying larger stocks. He still buys small-cap issues; he just holds onto them as they move into mid-cap or large-cap range.

The Fund Underperforms for a Long Period

While one year of underperformance may be nothing to worry about, two or three ugly years can get frustrating. The urge to sell intensifies.

Before pulling the trigger, be sure you're comparing your underperformer to an appropriate benchmark, such as its Morningstar category peers or a suitable index. Before you pass judgment, make sure the manager or strategy hasn't changed.

Your Goals Change

You don't invest to win some imaginary race, but to meet your financial goals. As your goals change, your funds should change as well.

Suppose you start investing in a balanced fund with the goal of buying a house within the next five years. If you get married and your spouse already owns a house, you may decide to use that money for retirement instead. In that case, you might ditch the balanced fund for a pure stock fund. Your goal and the time until you draw on your investment have changed.

You Just Can't Take It Anymore

The point of investing is meeting financial goals, not developing ulcers. If your fund is so volatile that not even the vision of your brand new house calms you down, then by all means sell—as long as you'd never buy the fund or a fund like it again.

The moral: Know your funds, know yourself, and never make the same mistake twice.

Quiz 504
There is only one correct answer to each question.

1 What is not a good reason to consider selling a fund?
a. It loses more than it should.
b. It gains more than it should.
c. It performs just as you expect.
2 Style shift:
a. Always indicates a change in strategy.
b. Sometimes indicates a change in strategy.
c. Is always a sell sign.
3 Before cutting an underperforming fund, check its:
a. One-year return against the market.
b. One-year return against its peers.
c. Longer-term returns (three-, five-, and 10-year) against an appropriate index and its peers.
4 If you began investing for retirement in 25 years and now your goal is to buy a home in two years:
a. You may need to sell some of your stock funds to shift into safer investments.
b. You may need to sell some of your conservative funds.
c. You shouldn't do a thing.
5 Is it okay to sell a fund that you've lost money on?
a. No.
b. Yes.
c. Maybe.
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