Should I Sell My Mutual Fund?
By Guest Contributor, Arielle O’Shea
The first quarter of 2016 saw one of the greatest stock market recoveries in modern history — it was the first time in over 80 years that the Standard & Poor’s 500 index dropped by more than 10% over three months and yet still managed to finish ahead of its start. Does this market volatility mean you need to sell your mutual fund?
In retrospect, the seesaw quarter underlines the advice experts give to long-term investors: Keep to your plan and stomach the troughs. Smart investing is like a long sea voyage, not a rapids shoot. The answer to the question, ‘Should I sell my mutual fund – due to the market ups and downs?’ is a resounding ‘No’.
Still, that doesn’t mean your holdings should be set in stone. Experts say there are scenarios — even in seemingly rosy times — in which you would do well to sell a mutual fund.
1. Should I Sell My Mutual Fund If It’s Performing Well – Maybe too Well?
Why would better returns be a sign of trouble? After all, isn’t that the whole point? Yes, but if your mutual fund shows dramatic gains compared with its peers, it may be worth investigating why, says Paul Jacobs, chief investment officer of Palisades Hudson Financial Group.
A short-term burst in performance could be “great while it lasts, not so great when the fund tanks,” he says. “For example, a fund could be borrowing money to boost returns or making investments you weren’t aware of,” he says. It could be a signal that the fund manager is doing market timing or taking on too much risk.
Compare your funds with the appropriate benchmarks, such as the S&P 500 or the Russell 3000 Index, and note whether they outperform the benchmarks by 5% or more. Look up the fund’s holdings and manager commentaries on the fund website.
2. Should I Sell My Mutual Fund If I Have a Bad Case of Asset Class Bloat?
A balanced portfolio is like a balanced diet — both are essential for your long-term health. If you’re eating more meat than greens, that’s going to come back to haunt your waistline.
Similarly, strongly performing mutual funds can result in a bloated asset class, such as stocks or bonds. If your stocks do well, a portfolio originally allocated to 60% stocks and 40% bonds can become a 70%-30% split instead. For many investors, that signals it’s time to rebalance the portfolio.
“By rebalancing regularly, you will continually be buying low and selling high,” Jacobs says.
3. Should I Sell My Mutual Fund if it’s a ‘Closeted’ Index Fund?
If your fund’s performance is essentially tracking an index, such as the S&P 500, while still charging a premium for active management, it may be time to reconsider that mutual fund. An index fund can sport fees as low as 0.07% of your account value, while an actively managed fund might charge a management fee of 1.0% or more over time.
“Over the long term, these ‘closet’ index funds tend to underperform their benchmark because of the management fees,” Jacobs says. “By monitoring a fund’s holdings periodically, you should be able to tell if the fund’s strategy is remaining consistent or if there are shifts happening that you disagree with.”
In general, most actively managed funds don’t outperform a passive asset allocation model. Unless there’s an extremely good reason for going with a high fee actively managed fund, you’re better off sticking with the low-fee index fund approach.
4. Should I Sell My Mutual Fund If I Have a Cheaper Equivalent Option?
As more exchange-traded funds and index funds compete on fees, costs are continually being driven down. Check to see if your online broker offers funds that are similar to the ones you already own but that have lower expense ratios. These fees are inherent in all mutual funds, index funds and exchange-traded funds, and over time they can significantly drag down your portfolio returns.
Forrest Baumhover, a financial planner and founder of Westchase Financial Planning, explains it this way: “If two investors have half a million dollars in something that is virtually identical in terms of investment philosophy and positions, but one is an index fund and tracks the market and the other is an actively managed fund that has similar performance, the difference [in what you’d pay in fees] could be 75 basis points.” (75 basis points is equivalent to 0.75%)
That amounts to almost $4,000 a year.
5. Should I Sell My Mutual Fund If I Want Off the Roller Coaster?
Stock market fluctuations aren’t a reason to change your portfolio. But if your current asset allocation is causing you to lose sleep, either because of stomach-churning market drops or a feeling that you need to invest more aggressively, perhaps it’s time to revisit your risk tolerance and investment targets.
“Determine how much risk you need to take to meet your goals,” Baumhover says. “There’s no reason to be going out there on a more aggressive scale if you don’t have to.”
In sum, a stay the course is usually a smart strategy, but there are times when you’re better off selling your mutual fund. Consider these 5 examples of situations when it’s time to sell your mutual fund.
Arielle O’Shea is an investment writer for NerdWallet and former associate with financial guru Jean Chatzky.