Things to keep in mind before selling a mutual fund
If your mutual fund is yielding a
lower return than you anticipated and is consistently performing badly than you
may be tempted to cash in your fund units and invest your money elsewhere. The
rate of return on other funds may look enticing but you should be careful as
there are both pros and cons to the redemption of your mutual fund units.
The first thing you need to understand is that mutual funds are not same as stocks. So, a decline in the stock market does not necessarily mean that it is time to sell the fund. Stocks are single entities with rates of return associated with the market. Stocks are driven by the "buy low, sell high" rationale, which explains why, in a falling stock market, many investors panic and quickly dump all of their stock-oriented assets.
Mutual funds on the other hand are not single entities; they are portfolios of financial instruments, such as stocks and bonds, chosen by a portfolio or fund manager in accordance with the fund's strategy. An advantage of this portfolio of assets is diversification. There are many types of mutual funds, and their degrees of diversification vary with each of them. Sector funds, for instance, will have the least diversification, while balanced funds will have the most. Within all mutual funds, however, the decline of one or a few of the stocks can be offset by other assets within the portfolio that are either holding steady or increasing in value.
Because mutual funds are diverse portfolios rather than single entities, relying only on market timing to sell your fund may be a useless strategy since a fund's portfolio may represent different kinds of markets. Also, because mutual funds are geared toward long-term returns, a rate of return that is lower than anticipated during the first year is not necessarily a sign to sell.
The following are the situations when you should consider selling a fund, though it is always not necessary but these are situations in which you should at least raise a red flag:
Change in a Fund's Manager
When you put your money into a fund, you are putting a certain amount of trust into the fund manager's expertise and knowledge, which you hope will lead to an outstanding return on an investment that suits your investment goals. If your quarterly or annual report indicates that your fund has a new manager, pay attention. The prospectus should indicate the reason for the change in manager. If the prospectus states that the fund's goal will remain the same, it may be a good idea to watch the fund's returns over the next year. For further peace of mind, you could also research the new manager's previous experience and performance.
Change in Strategy
If you researched your fund before investing in it, you most likely invested in a fund that accurately reflects your financial goals. If your fund manager suddenly starts to invest in financial instruments that do not reflect the mutual fund's original goals, you may want to re-evaluate the fund you are holding.
Consistent Underperformance
This can be tricky since the definition of "underperformance" differs from investor to investor. If the mutual fund returns have been poor over a period of less than a year, liquidating your holdings in the portfolio may not be the best idea since the mutual fund may simply be experiencing some short-term fluctuations. However, if you have noticed significantly poor performance over the last two or more years, it may be time to cut your losses and move on. To help your decision, compare the fund's performance to a suitable benchmark or to similar funds. Exceptionally poor comparative performance should be a signal to sell the fund.
When Your Personal Investment Portfolio Changes
Besides changes in the mutual fund itself, other changes in your personal portfolio may require you to redeem your mutual fund units and transfer your money into a more suitable portfolio. For example you may have need to rebalance your portfolio or you may need a tax break to offset realized capital gains of your other investments and for that you may want to redeem your mutual fund units in order to apply the capital loss to your capital gains.
When Selling Your Fund following are the factors you should take care of:
When you are cashing-in your mutual fund units, there are a couple of factors to consider that may affect your return:
Exit loads - If you are an investor who holds a fund that charges a back-end load, the total you receive when redeeming your units will be affected. If your fund has a back-end load, charges will be deducted from your total redemption value. For many funds, back-end loads tend to be higher when you liquidate your units earlier rather than later, so you need to determine if liquidating your units now is optimal.
Tax consequences - If your mutual fund has realized significant capital gains in the past, you may be subject to capital gains taxes if the fund is held within a taxable account. When you redeem units of a fund that has a value greater than the total cost, you will have a taxable gain. So you should check before redeeming your units whether it makes sense after taking taxes into consideration.
Do keep in mind that even if your fund is geared to yielding long-term rates of returns, that does not mean you have to hold onto the fund through thick and thin. The purpose of a mutual fund is to increase your investment over time, not to demonstrate your loyalty to a particular sector or group of assets or a specific fund manager. So if your fund is performing badly consistently than you can consider selling it.
