When to dump an underperforming fund |
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Has the style of the fund changed?
Martinez says that if your fund is underperforming, you should take a hard look at whether it is adhering to its stated investment parameters.
"In our opinion, the most important reason to dump a fund would be style drift," he says. "Believe it or not, that would trump even underperformance."
Says Peterson: "Style drift is a red flag for me. I want to rely on my manager's style. If a manager changes style
midstream, that messes up my portfolio allocation."
Brown is more lenient with regard to style. "Sometimes we can get so bent on getting style-pure that we miss a good manager who has skill at moving around and capturing return," he says, adding that if this were the case, he would consider holding the position.
Has the management changed?
A management change could explain a fund's underperformance and may be a reason to sell, says Peterson.
"A manager change is an amber flag," he says. "If
a superstar manager leaves, we will keep the fund on a watch list.
We don't automatically change ... because often the second in command
or the team behind him has been involved and can take over the reins."
Brown concurs. "If we don't understand the new team or didn't see mentorship or some sort of passing of the torch, we might sell."
Did you pay an expensive charge to get into the fund?
Many funds have a sales load, a charge you pay for entering or exiting the funds. Hughes warns investors to check what they've paid.
"If you've got a load fund and it isn't doing well, it's time to see if you're getting what you're paying for," she says. If analysis proves that the fund isn't likely to recover, she advises clients to take the loss on the load.
"Take your hit and get into something that will cost less and you don't have to make such a big jump in return," she says.
What are the tax consequences of a sale?
Even if you've recently lost money, you may still have short- or long-term capital gains. Brown weighs the tax trade-offs with the possibility of continued poor performance when considering the sale of an underperforming fund for his clients. "Taxes are certainly included in the mix of considerations ... but are not the main consideration."
Martinez echoes his comments. "We find that individuals tend to ride funds down without selling in an attempt to protect themselves from recognizing taxable events."
If you decide to sell and pay capital gains, Moffitt reminds taxpayers that "when trading the fund, one can indicate certain tax lots to be sold and in what priority."
Weigh all the data
If you've carefully examined the role of the fund in your portfolio, analyzed performance in relation to the market and to its peers, waited an appropriate period of time, considered the sales load sacrifice or tax consequences and still conclude that performance is not going to get better, then selling may be the best alternative.
"You might have to say, 'Oops, I made a mistake,'"
says Hughes. "Sometimes taking the hit and moving on is the better
decision, because waiting years for it to get better won't serve
you well."
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