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When your mutual fund plummets in value
Dear Dollar Diva,
I received a $7,000 inheritance when my grandmother
died last year and invested it in a no-load, aggressive-growth mutual
fund. It is now worth barely $3,000. When I first bought the fund,
Morningstar gave it a 5-star rating; a couple of months later, it
was down to 3-stars. Should I sell this dog? I am 27 years old and
single; my investment goal is long-term growth.
Nina
Dear Nina,
Congratulations on selecting a no-load fund.
At least you don't have to agonize over losing a 5 or 6 percent
load if you decide to sell.
Your fund is down a whopping 57 percent -- ouch. Most
equity mutual fund investors are suffering post-traumatic stress
over their recent losses; a glance at the Russell
U.S. equity index returns shows that the market took a beating
over the past year. The Diva will address your fund's hefty loss
after she answers your question.
Should you sell?
Selling is a way to make lemonade out of this lemon. Since
your mutual fund is not in an IRA or other tax-deferred retirement
plan, you can sell all or part of your investment and take the capital
loss deduction. Then, immediately reinvest the proceeds in another
mutual fund, to keep the money working for you.
But be careful: If you fall back in love with this
particular fund you need to know about the IRS
"wash sale" rule before you buy it back again: If
you buy a "substantially identical stock" within 30 days
before or after the sale of stock that you previously owned, you
cannot take the loss deduction.
Substitute "mutual fund" for "stock,"
and it means, if you want to take the loss, you have to wait 30
days after you sell before you can buy the same mutual fund back
again. However, there's no law that says you can't purchase a different
aggressive-growth fund or any other kind of investment that makes
sense to you.
Reminder: If you don't have capital gains to offset
the capital loss, the maximum capital loss deduction allowed in
any one year is $3,000. But don't worry: if your loss is greater
than $3,000, you won't lose it. You can carry it over to future
years to offset capital gains and/or deduct the maximum $3,000 capital
loss each year until it's used up.
Morningstar's ratings
It sounds like you're familiar with Morningstar and its
"star rating" system. Morningstar provides independent,
mutual fund and stock analysis, but its mutual fund ratings are
on past performance only. It's too bad you had to learn the hard
way that past performance is no guarantee of future results.
The Morningstar "star rating" is not the
best tool for measuring your fund's performance against other funds
in its category. The "star rating" system would have compared
the performance of your mutual fund against the performance of the
whole domestic-equity universe, even though your aggressive growth
fund might only invest in small or mid-cap growth stocks. The "star
rating" system often ends up comparing apples with oranges
and is not the best research tool for measuring most mutual funds.
The better rating is the "category rating."
It's on the same front page of the Morningstar
Quicktake Report as the "star rating," so it's easy
to find. Your fund's risk and return will be compared with funds
in the same category (i.e. large-cap, mid-cap or small-cap; growth,
value or blend); apples will be compared with apples; oranges with
oranges.
For more on mutual fund ratings, read Morningstar's
"Secrets
of the Morningstar Rating for Funds" (registration required).To
understand the various categories of funds, read the Diva's "401(k)
allocations for twenty-somethings." The concept of asset
allocation is key to successful investing; if you don't understand
it, this is a must read.
If you sell, what should you
buy?
Your fund's 57 percent loss is pretty awesome, but not unheard
of; the 21st century found many aggressive-growth funds drowning
in the high tech blood bath. One high-tech player, Lucent Technologies,
lost almost 80 percent of its value over the past 12 months, and
it has plenty of company.
But history tells us that categories of stock regularly
jump from the bottom of the heap to the top. Sometimes it happens
in a year, sometimes it takes a couple of years, and sometimes a
category slides around in-the middle before it moves up or down.
The one sure thing is: No category stays on the top or bottom forever.
The Diva is not a mutual fund analyst and she doesn't
know what fund you own, or if it's any good. She's going to link
you to Morningstar's "When
to sell a fund" to help you make a decision on your fund,
and on whether you should stay with aggressive growth or move your
assets into something less volatile. The six areas it touches on
are:
1. The fund loses more than it should.
2. The fund gains more than it should.
3. The fund changes strategy.
4. The fund underperforms for a long period.
5. Your goals change.
6. You just can't take it any more.
You have to remember that investing in aggressive-growth
stocks is a long-term bet. At 27, you have the time to weather the
ups and downs of this type of investing. But do you have the stomach
for it?
Index funds
If you don't have the time or inclination
to research a fund and read its prospectus before you buy, you should
go with a no-load, low fee index fund that follows the market you
are interested in. Vanguard
is the big daddy of index fund investing, but many other financial
institutions offer them too. Use your favorite search engine to
help you sniff them out.
-- Posted: Dec. 10, 2001
 DOROTHY
ROSEN has a master's degree in finance, with a specialization in
accounting, from the Kellogg Graduate School at Northwestern University
in Evanston, Ill. Rosen has more than 15 years of experience in
the financial arena, serving in Illinois and Florida as a certified
public accountant, financial consultant, expert witness and educator.
She is owner of Dorothy Rosen, CPA, a public accounting firm that
serves individuals and small businesses.
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