Are you holding funds that should be sold?
Many investors struggle to sell their funds, and some end up holding out-of-favor funds for years because they’re not sure when or if it’s time to move on.
There’s plenty of information about what funds to buy, but there aren’t as many resources about what funds to sell, and yet knowing when to sell is a critical investing skill.
Studies find that investors tend to sell at inopportune times. For instance, they sell when markets fall in an attempt to avoid losses, and yet they may end up missing on out gains.
DALBAR, a financial research firm, that’s been analyzing fund investors’ returns for the last 24 years has found that this behavior is a primary reason why investors tend to underperform.
Getting better at selling funds can help you keep your investments in shape and may even improve your results.
So, if you’ve got funds in your portfolio today that you’re thinking about selling, here are four key questions to answer first:
1. Why did I buy this fund, and are those reasons still in place?
You invest for a reason. Perhaps you bought a fund because it had a good track record or a well-respected manager or a unique investment approach. Or maybe you bought a fund because a trusted friend thought it was a good investment.
Now consider if that reason is still valid. Is the fund still highly rated? Does it have the same manager or strategy? Does your friend still own it? The answer to this question can be a sell signal.
(If you find you can’t remember why you bought a fund, start writing down your rationale when you make a purchase so you can refer to it later.)
At FundX, my team and I invest in a fund when it’s outperforming other funds with similar risk, so we monitor a fund’s performance closely and if performance falters, that’s a clear sign that it’s time to move on.
2. Does this fund play an important role in my portfolio?
Your funds should work together in your portfolio, but often investors hold too many similar funds which makes effective management more difficult. Think about what would happen to your portfolio if you sold this fund.
If a fund adds diversification, for instance, would selling it lead you to own a more concentrated portfolio? If you own funds to help buffer stock market volatility, would you be able to weather future market corrections if you sold this fund?
3. How long have I held the fund and will I face fees or taxes if I sell?
Some funds and almost all brokers charge a redemption or short-term trading fee for selling a fund within a certain period of time (broker holding periods usually run about 90 days). You’ll want to make sure you understand your broker’s policies before placing a trade so you don’t get hit with an unexpected fee.
If you own funds in a taxable account, you should consider the potential tax implications of selling a fund. If you have a sizeable gain in a fund, look at how long you’ve held it to see if you’d realize long-term or short-term gains if you sold it. (Long-term gains are taxed at a lower rate than short-term ones.)
4. What will I do with the proceeds from the sale?
Before you sell a fund, you should know what you plan to do with money. If you need to be fully invested (and most investors do), you’ll want to decide up front what fund you’ll buy instead.
I’ve talked with investors who ended up in cash for years because they weren’t sure what else to buy or they were waiting to try to find just the ‘right’ fund to own. This can really hold you back.
Here at FundX, our investment process leads us to sell funds when they aren’t performing as well as other funds with similar risk and replace those funds with stronger performers.
Here’s one more way to see if you’re holding a fund that should be sold: Ask yourself if you’d buy this same fund again today? Financial advisor Carl Richards calls this the overnight test: if you woke up tomorrow find your portfolio in cash, would you buy into these same funds? If the answer is no, you probably have some funds to sell.
This post by FundX President Janet Brown initially appeared on Forbes.