Yesterday’s value darlings can easily become dogs of the market during a bull market. Lists of the best performing mutual funds change from week to week. It is tempting to dump the value funds and jump into growth mutual funds. But hold on! Reactive investors earn lower performance, so how do you know when it is a good time to buy and sell mutual funds?
Here are the two biggest reasons not to sell your mutual fund.
Performance Decline From Churn
Active traders realize lower portfolio returns than buy-and-hold investors. If you are jumping to the highest performing stock, it may also be a more volatile stock. When performance is smoothed out over time, passive investments perform better.
Higher Costs of Buying & Selling
- Unlike exchange-traded funds (ETFs), mutual funds do not trade like stocks on an exchange. One price is reported daily. You may end up selling a winning fund.
- If your fund is in a taxable account, you will be required to pay capital gains tax when you sell it.
- You may be charged fees by the fund company when you sell your fund.
- You will be charged fees when buying new funds
So When Is It a Good Time to Buy and Sell a Mutual Fund?
- Low Performance
It is easy to sell your mutual fund when it is underperforming the market. Biotechnology ETFs are outperforming most sectors, so why not dump the lowering performing fund? If you are satisfied achieving market returns then you may even want to go with an index fund, which replicates the performance of an index. Know the difference between a mutual fund versus an index fund, and in which situations they are best for you. If you are saving for retirement and want automatic monthly payroll deductions, mutual funds are best.
- Paying too High of Fees
Mutual fund fees can change over the course of your ownership. You may have chosen your fund for its low fees and comparable performance over a more expensive fund. Mutual funds are not required to keep fees at the rate you signed up at. High fees can cut into the performance of your fund. It is a good practice to review the fees on all of your investments on a regular basis.
- Change in Management
A change in managers could be a death knell for an actively managed fund but have little influence on a passive fund that tracks an investment index. The change may be unrelated to performance. Some funds are so strongly identified with their manager that the fund risks high capital outflows if the manager were to leave. Mutual funds have adopted the practice of assigning two or more managers to a fund to avoid a fund’s performance being too strongly associated with one fund manager.
One such fund manager with rock star appeal is Peter Lynch, the legendary manager of the Fidelity Magellan Fund. An investment of $1,000 in the Magellan Fund in 1977 would have been valued at $28,000 in 1990. The fund actually also did very well in the years Lynch was not the manager. Fidelity’s successful investment strategy was replicated. A change in management does not mean you should sell, but do keep a closer eye on your fund’s performance.
- Change in Investment Style
How could a mutual fund change its investment style? you ask. True, the ABC Value Fund is not going to change its name to the ABC Growth Fund, but it could indeed start performing like a growth stock. When in a bull market, value managers sometimes lace their value funds with growth stocks to boost performance. These high octane value funds are at a higher risk of quickly declining in value if market growth slows.
The managers will then seek to sell the growth stocks. As we already mentioned, overall, active managers do not do as well as passive managers long term. For this reason, you should also ensure the turnover on your fund is not high compared with comparable funds.
- Portfolio Rebalancing
Periodically, you should review your investment performance. Successful investors sell poor performing investments and increase their investments in good performers.
Mutual fund investors who buy and sell on a schedule, ignoring market volatility, earn higher returns than investors who trade on price signals.
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