Reprinted with permission from World Finance Net IPO Newsletter, written by Maureen Wells.


TV voices advise you on the hottest mutual funds, the mailman delivers financial advice, everyone is telling you what and when to buy stocks, bonds and mutual funds. But just about nobody talks about selling. So it comes as no surprise that many investors have more difficulty with sell decisions than the buying ones. Although mutual funds rightfully attract those with a long-term horizon, the buy and hold strategy can be overruled by events that can indicate a reason to sell a mutual fund. We will look at some of the yellow flags that signal when a mutual fund should be placed on your sell watch list.

Before we get to the yellow flags, history shows that many investors sell mutual funds for the wrong reason. When the stock market takes one of its dives, mutual fund outflow numbers have shown that fund redemptions soar. This is call panic selling, and it is not a good thing. It is certainly difficult to sit idle while dollars disappear from your mutual fund statements. Its easy to get caught up in the emotional turmoil of a down market, pull the trigger and sell.

Resist the impulse. Investing successfully over the long term demands that you put as much thought, research and sweat into a sell decision as you did when you bought the fund.

Moreover, in todays volatile market place, performance is not necessarily a reason to sell. With a balanced portfolio, you should hold a selection of asset classes that do not all out-perform or lag in unison. History has shown that every asset class has its day in the sun. For example, value funds were doing well until last year when growth stocks began to rally.

The first logical step in assessing whether a mutual fund is a keeper is understanding the asset class to which it belongs and then measuring its performance. When investors think a fund is lagging the market, they are sometimes measuring it against the wrong index, and that index is usually Standard & Poors 500 (S&P500) because it is very well known. But if you have a small cap fund or a global fund, for example, the S&P is the wrong benchmark. So, be sure to measure your fund against a relevant index. If uncertain about which one to use, check the fund prospectus or the latest semiannual report for the information.

Now, to yellow flag number one. If you do the above research and find your fund is starting to fall behind the appropriate benchmark, it should be placed on your watch list. With no visible improvement after 12 months, more than enough time for a good manager to make the necessary adjustments, a sell decision could be a good one.

In event of a portfolio management change or corporate upheaval, flag number two goes up and attention should be paid; and more so, if the fund has been closely associated with one manager instead of a management team. When Michael Price departed from Franklin Mutual Series Funds, performance suffered. But when the storied Tom Marisico left Janus Twenty Fund, his successor maintained his performance standards. So, departure of a manager does not always spell doom, however the fund should be monitored. Management fights can be just as damaging. His funds suffered when the well known Louie Navallier took his management company to court.

Yellow flag three is style drift. If a manager is changing investment philosophy to chase returns, it can cause havoc with the asset allocation structure of your portfolio. If your small cap fund manager starts drifting into large cap growths, your portfolio could turn into an underexposed, over weighted situation.

Flag four is when a manager starts to stockpile cash in the mutual fund. Rapid cash inflows must be quickly converted into equities or performance will suffer. It may mean that the fund is growing too quickly or that the manager has shifted styles.

Yellow flag five is overall size. Sometimes size does matter. Too much money hitting a fund too fast can be destructive. Often the price of success is a drop in performance. Most hard hit are small-cap and micro-cap funds which invest in stocks that are, by definition, less liquid. Many financial planners suggest keeping an eye on small cap fund with assets above $500 million and mico-cap funds with assets above $200 million. Large caps are given more leeway but anything more than $1 billion should be raise an eyebrow.

With the current bull market being led by large cap growth stocks, your portfolio may well be out of whack. Approaching the end of the fiscal year, it may be a good time to review your portfolio of equity funds. Diversification is as important now, as ever. If your plan includes a particular allocation of large and small caps, yellow flag number 6 kicks in. It might be a good time to consider selling off some of the large-cap winners and moving the money into the smaller-caps. After all, every asset class has its day in the sun.

The six yellow flags, however, are only a first step toward any mutual fund selling decision. To sell or not to sell requires patient reflection. Dont be pulled by a single event. Rather, study trends, research and follow events so that any sell decision is based on careful analysis. But, yes, there are times when you should head for the exit, even if no one is saying it out loud.


Click here for more investment analysis and research from World Finance Net.