Investing in mutual funds takes work. Whether you own actively managed funds or index funds you still need to monitor your holdings. Here are four reasons you might consider selling a fund other than simply disappointing returns.
A significant outflow of dollars.
Mutual fund managers generally try to stay fully invested within their investment mandate. When a fund experiences a high level of redemptions the managers may need to keep more cash on hand to meet these redemptions. This cash is not being invested in the stocks, bonds or other vehicles that the fund focuses on.
A significant inflow of dollars.
Money often follows success. Invariably last year's hot fund will attract more investors hoping to cash in. Too much new cash in too short of a time frame can pose a problem for a fund manager in terms of finding good investment ideas within the fund's investment style. This is not so significant for an index fund or fund that invests in larger cap stocks, but for a fund investing in small- or mid-cap stocks it can be a real problem. Funds that are genuinely concerned about their shareholders will close to new investment before size becomes an issue. Those that don't often see their performance suffers or migrate their fund to a different investment style. For example, a great, focused small-cap fund might morph into a mid-cap fund simply because it needs to invest all that extra cash. You have to ask yourself if the outstanding small-cap manager will be an equally good mid- or large-cap fund manager.
A change in personnel.
For an actively managed fund, a manager change is a significant event. Who will be in charge going forward? Will the fund's investment style stay the same? This can also be an issue for an index product in terms of a change in its indexing methodology.
Personnel issues in the management of the fund company can also be an issue. New management at the top can signal changes that filter down to the fund level so this is also something to monitor and be aware of.
A change in the fund's investment style.
I alluded to shifting investment styles above, but it's worth repeating. If a fund moves from being a small-cap fund to an all-cap go-anywhere fund, the change in its holdings or risk profile mean it might not fit in your portfolio in the same way (or at all). Additionally fund style changes can cause overlap with your other holdings possibly resulting in more risk than you had planned on.
Funds eating funds.
Within certain guidelines fund companies are allowed to merge funds into other mutual funds within their families. This will often occur when one or more funds are underperforming or perhaps not drawing in as much in assets as the fund company would like. There are rules about restating past results for the surviving fund, but nonetheless if this happens to a fund you own, or recently took place in one you are thinking of buying, be sure to dig in on the details, holdings and performance of the surviving fund to be sure it makes sense for you.
Mutual fund investing is not about sending in your money and forgetting about it. Successful mutual fund investors monitor their holdings and make changes when and if needed based upon a number of factors. Certainly results are key, but they aren't the only metric by which funds should be judged. What factors enter into your decisions about your mutual fund holdings?
Roger Wohlner, CFP®, is a fee-only financial adviser at Asset Strategy Consultants based in Arlington Heights, Ill., where he provides financial planning and investment advice to individual clients, 401(k) plan sponsors and participants, foundations, and endowments. Roger is active on both Twitter (@rwohlner) and LinkedIn. Check out Roger's popular blog The Chicago Financial Planner where he writes about issues concerning financial planning, investments, and retirement plans.