3 Bad Reasons to Sell a Fund

Performance, especially, can lead investors to sell funds that they should hold on to

Christine Benz 15 August, 2014 | 12:37AM
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The decision about whether to sell a fund is usually not clear-cut, even in hindsight.

After the dust has settled on a decision and the investment has performed well or poorly, the "right" answer is wholly dependent on the individual. It's difficult to arrive at selling criteria that fit every investor. But there are some situations when selling is especially ill-advised. Here are four of the key ones.

Bad Reason 1: Weak Short-Term Performance

It's almost never a good idea to sell a fund based on weak performance alone, whether short- or long-term. Instead, if a fund is lagging its peers or an index, your first move should be to investigate why that is. It could be that the manager is simply sticking with an investment strategy that happens to be out of favour, as was the case with many value-leaning funds amid the tech boom of the late 1990s. Such discipline is often vindicated over time. But weak performance may be a sign that something more serious is afoot—for example, perhaps your fund is lagging in a market led by small-caps and mid-caps because it's become too large and the manager can only put all that money to work in larger-cap stocks.

Researching an investment's fundamentals can be time-consuming, which is why you don't want to get too caught up in investigating short-term bouts of underperformance. Most funds, especially those that are using truly active strategies, will trail their peers at times, often for very good reasons and for a few years or more. (Indeed, that's been the case with some perfectly solid, defensively positioned funds over the past five years.) Instead, save your energy for checking up on funds when they've underperformed over longer stretches of time or in a period when you would have expected them to perform well. If, for example, you prized a fund because of its low-risk tendencies, but it lost far more than its peers in 2008, that's a legitimate reason to ask whether something about its strategy changed or its risk controls weren't what you thought they were. Even if the fund isn't bad, it may not be a good fit in your portfolio.

Bad Reason 2: Inconsistent Performance

In a related vein, investors often get themselves worked up when a fund's relative returns are inconsistent on a year-to-year basis. Sure, it can be comforting to see a fund land in its category's top half like clockwork—and a small handful of funds has actually managed to generate return rankings that have been remarkably consistent from year to year.

But holding all of your holdings to that standard would cause you to kick out some fine offerings that, while not consistent performers on a calendar-year basis, are consistent where it counts: They employ their strategies with discipline and don't waver, even if the market isn't rewarding them in the near term. It's also important to remember that a calendar year is a fairly short and arbitrary time period, and the fund that has looked erratic over January-December time periods may appear perfectly consistent when measured over a different 12-month time frame—say, from April to March of each year. Investors shouldn't get too hung up on year-to-year performance consistency when deciding what to hold in their portfolios.

Bad Reason 3: Macroeconomic News 

Macroeconomic news, whether it's the direction of UK interest rates or GDP growth in China and India, often appears right alongside news about the market's trajectory. And it's true that what's in the headlines has the potential to move the markets up or down on a daily basis, or even over longer time frames. The trouble is that by the time a certain news item makes its way into the headlines, other market participants have already digested it and priced it in. If you decide to sell your fund based on that news, you're likely to be too late. Instead, a better tack for investors, at least as it relates to their portfolios, is to keep their heads down and focus on factors that they can control: their savings and spending rates, the quality of their investment holdings, and the total costs they pay for those investments. There is much virtue in tuning out the noise when it comes to managing your portfolio.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

Christine Benz

Christine Benz  is director of personal finance at Morningstar and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances.