Arvind Bansal of ING Investment Management says the key to having a good 2009 is knowing when & how to review your mutual fund investment strategy:
If your mutual fund investment is yielding a lower return than you anticipated, you may be tempted to cash in your fund units and invest your money elsewhere. The rate of return of other funds may look enticing, but be careful: there are both pros and cons to the redemption of your mutual fund units. Let's examine the circumstances in which liquidation of your fund units would be most optimal and when it may have negative consequences.Mutual Funds are not stocks
The first thing you need to understand is that mutual funds are not synonymous with 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 what the market will bear. 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 are not singular entities; they are portfolios of financial instruments, such as stocks and bonds, chosen by a fund manager in accordance with the fund's mandate. An advantage of this portfolio of assets is diversification. There are many types of mutual funds, and their degrees of diversification vary. 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 an ineffective 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.
When Your Fund Changes
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. Kenny Rogers once said, "The key to successful mutual fund investing is "knowing when to hold 'em and knowing when to fold 'em".
The following four situations are not necessarily indications that you should fold, but they are situations that should raise a red flag:
- Change in Fund Manager: When you put your money into a fund, you are putting a certain amount of trust into the fund house & fund manager’s expertise and knowledge, which you hope will lead to an outstanding return on an investment that suits your investment goals. A category of investors track the fund managers more than they track the fund house and its schemes. These investors invest in a mutual fund relying mainly on the star fund manager's investment prowess and skills. One should always invest in process-driven fund houses; this is a more reliable way of investing than betting on star fund managers.
- 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 Fund 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 changes the investment mandate that do not reflect the mutual fund's original goals, you may want to re-evaluate the fund you are holding. For example, if your small-cap fund starts investing in a few medium or large-cap stocks, the risk and direction of the fund may change. Note that funds are typically required to notify shareholders of any changes to the original prospectus.
- Additionally, some funds may change their names to attract more customers, and when a mutual fund changes its name, sometimes its strategies also change. Remember, you should be comfortable with the direction of the fund, so if changes bother you, then its time to redeem it.
- In the event of a revision in the mandate, regulations require that investors be given the option to redeem the mutual fund without an exit load, so you can redeem the investment without worrying about the exit load (if any).
- Change in Fund Performance: If the mutual fund returns have been poor over a period of less than a year, liquidating your holdings in the fund 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.
- Equity funds should ideally be evaluated over the long-term (at least 3 years). Taking a decision in haste without understanding the investment proposition of the mutual fund could prove counterproductive and expensive (if there is an exit load).
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. Here are two reasons which might prompt you to liquidate your mutual fund units:
- The need to rebalance your portfolio - If you have a set asset allocation model to which you would like to adhere, you may need to rebalance your holdings at the end of the year in order to return your portfolio back to its original state. In these cases, you may need to sell or even purchase more of a fund within your portfolio to bring your portfolio back to its original equilibrium. You may also have to think about rebalancing if your investment goals change. For instance, if you decide to change your growth strategy to one that provides steady income, your current holdings in growth funds may no longer be appropriate.
- Need a tax break - If your fund has suffered significant capital losses and you need a tax break to offset realized capital gains of your other investments, you may want to redeem your mutual fund units in order to apply the capital loss to your capital gains.
Conclusion:
Selling a mutual fund isn't something you do impulsively, without a great deal of thought and consideration. Remember that you originally invested in your mutual fund because you were confident in it, so make sure you are clear on your reasons for letting it go. However, if you have carefully considered all the pros and cons of your fund's performance and you still think you should sell it, do it and don't look back. Before you press the sell button, take stock of the tax implications and exit loads, if any. And given that market movement are random and not in the hands of the investors, don't try to time your exit.
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