Deciding when to dump a fund
Online calculators, Web sites can help
By BROOKE A. MASTERS
Washington Post
8/20/2006
After the stock market slide in May and June, many investors cringed when they opened their second-quarter mutual fund statements. Losses were widespread, and a lot of the standard index-tracking funds were down or flat for the quarter.
But for some investors, the bad news could serve as a wake-up call to take a fresh look at their mutual fund holdings to see whether the funds they hold are living up to expectations.
First, investors should determine whether the problem is with the fund or simply the sector it tracks. In the bull market of the past few years, small-company and international stocks did far better than large, blue-chip companies. The reverse has been true in the recent slide.
"Look at how a fund has compared to its category peers. You don't want to compare every fund to the (Standard & Poor's) 500. You don't want to compare an international fund to a U.S. stock index," said Christine Benz, director of fund analysis for the research firm Morningstar Inc.
Morningstar's Web site, www.morningstar.com, allows investors to look up a fund's total return in comparison to its peer group. It also rates funds with one to five stars based on their past performance.
It also may be worthwhile to look up potentially troubled funds at FundAlarm.com, which highlights mutual funds that have underperformed their benchmark for the past 12 months, three years and five years. It also tracks management changes and other issues involving mutual fund companies.
One key piece of information in deciding whether to dump a fund: its expense ratio. A fund's return depends on its absolute return minus its fees. So if two funds are substantially similar - say, they are both index funds that seek to mimic the Russell 2000 Index of small companies - the one with the lower fees should do better.
Fees come in different categories and sizes, but NASD offers an online calculator that allows investors to compare up to three funds head to head at www.nasd.com/fundanalyzer.
There's another common problem with mutual funds: Investors chasing performance sometimes end up buying so many funds that many of them overlap and hold most of the same stocks.
"That's the most common mistake I see, investors coming in with 15 funds and they're all tracking the S&P 500," said Middleburg, Va., independent financial adviser Helen Modly.
Investors might do better consolidating their money into fewer funds that are easier to track and cover a wider range of stocks.
For investors who buy through a broker and have to pay a commission, called a load, consolidation in a single fund family has an added benefit: Many fund companies offer "break points" - reduced commissions - to customers who invest a large amount of money (generally $50,000 or more) in their family of funds. NASD has a site where investors can determine which funds offer break points at www.nasd.com/fundsearch.
But deciding to get out of a bad or inappropriate mutual fund isn't always simple. Some funds charge a redemption fee if investors pull out too fast. Usually the penalty period is reasonably short, less than a year, but some funds with "Class B" shares charge what they call a "back-end load" for more than five years.
In many cases, long-term investors may do better waiting for a penalty period to expire before selling their shares, Benz said. The other option would be to move money to a better fund run by the same mutual fund company. In that case, there is generally no penalty.
Similarly, selling a fund may involve substantial capital gains - the difference between a fund's cost and its selling price - for investors who have done well in the past with a particular fund. Long-term capital gains taxes, which apply to assets held for more than 366 days, are substantially lower than the taxes on short-term gains.
In either case, if your fund is down substantially right now, maybe you should bite the bullet and sell because the resulting capital gains taxes would be relatively low.
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