Investing in mutual funds takes work, even index funds. Whether you own actively managed funds or index funds you still need to monitor your holdings. Here are 7 reasons you might consider selling a mutual fund holding.

A significant outflow of dollars

In my view, mutual fund managers should try to stay fully invested within their investment mandate. If I am investing in mutual fund in the large growth style, I want those dollars invested in large cap growth stocks.  I don’t want an equity fund manager deciding to be in cash, if I want to be in cash I’ll put that portion of the portfolio in a money market fund.   When a mutual fund experiences a high level of redemptions the managers may need to keep more cash on hand to meet these redemptions. This cash is not being invested in the stocks, bonds or other vehicles that the fund should be focused on.  In an up market like this one excess cash can be a drag on returns.

A significant inflow of dollars

Money follows success. Last year’s hot fund will attract more investors hoping to latch on to the fund’s success. Too much new cash in a short time frame can pose a real problem for a fund manager in terms of finding good investment ideas within the fund’s investment style.

This is not as significant for an index fund or a fund that invests in larger cap stocks.  However, for a fund investing in small- or mid-cap stocks this can be a death knell in terms of future success. I really admire mutual fund companies who close popular funds when they become too large.  Two that come to mind are Sequoia Fund (SEQUX) which was closed for over 20 years at one point and recently closed again after reopening for a couple of years (purchases can only be made directly from the fund company last time I checked).  Another is Artisan Funds and their Artisan Mid Cap Value Fund (ARTQX).  The mention of these funds should not be construed as investment advice in any way, shape or form. 

The flip-side is funds that simply allow new money to come in droves.  All too often these once stellar performers become tomorrow’s laggards.  I don’t know if this behavior is born out of stupidity, greed, hubris, or all three.  At the very least a fund taking in a vast amounts of new money should be raise a red flag as you monitor your portfolio. 

 A change in personnel

For an actively managed fund, a manager change is a significant event. Who will be in charge going forward? Will the fund’s investment style stay the same? This can also be an issue for an index product in terms of a change in its indexing methodology.

Personnel issues in the management of the fund company can also be an issue. As an example once high-flying Janus Funds has experienced heavy turnover in the executive suite over the past decade.  There has also been a fair amount of management turnover in many of the company’s mutual funds.  I find it hard to believe that this doesn’t have an impact on day to day operations and the management of the funds.

A change in the fund’s investment style  

I alluded to shifting investment styles above, but it’s worth repeating.  For example I recently suggested to the Committee of 401(k) plan for whom I serve as investment advisor that we remove a mutual fund whose investment style had shifted along with their investment methodology and some of the fund’s personnel.  While there’s nothing wrong with a go-anywhere fund that is style agnostic, if your intent is to invest in a mutual fund that invests in small cap growth stocks you should consider replacing that fund if its investment style changes to say small cap blend or value.

Fund mergers

Mutual fund companies sometimes merge laggard funds into other mutual funds within their families.  There are rules about restating past results for the surviving fund, but nonetheless if this happens to a fund you own, or recently took place in one you are thinking of buying, be sure to dig into the details, holdings and performance of the surviving fund to be sure it still makes sense for you as a part of your portfolio.

The reasons listed above often warrant selling out of mutual fund entirely.  Here are two additional reasons to consider a total or partial sale that have nothing to do with negative developments with the fund. 

Donating appreciated fund shares 

As year-end approaches many of us look to make contributions to our favorite charities.  If you own shares of a mutual fund that has appreciated in value donating some or all of the shares to the charity is an excellent and tax-efficient way to make this contribution.  By donating appreciated shares owned in a taxable account (as opposed to a tax-deferred account like an IRA) you avoid paying capital gains taxes that would be due if the shares were simply sold.  You also receive a charitable deduction for the full market value of the shares donated.  Many charities have the capacity to receive donations in this fashion. 

Rebalancing your portfolio 

I generally suggest that most people look to rebalance their portfolio back to its intended asset allocation at least once or twice annually.  For example with the solid gains in most equity asset classes this year and the relatively flat to down performance of many fixed income asset classes, it is likely that your portfolio is over allocated to equities.  This potentially exposes you to more risk than your financial plan and your asset allocation calls for.  It is very appropriate in this case to sell off some of your mutual fund (or other investments) holdings where you are over allocated and adding to fund positions in areas of the portfolio that have become under allocated. 

I am not an advocate of the frequent buying and selling of mutual funds or any other investment vehicle for that matter.   However, mutual fund investing is not about sending in your money and forgetting about it. Successful mutual fund investors monitor their holdings and make changes when and if needed based upon a number of factors.  

Please contact me at 847-506-9827 for a complimentary 30-minute consultation to discuss all of your financial planning and investing questions. Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services.

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