10 Reasons to Sell a Mutual Fund Other Than Poor Performance

There are at least 10 good reasons for dumping a mutual fund or an ETF besides poor performance.

1. The fund did too well—for all the wrong reasons.

If your fund has dramatically outperformed its peers over the short term, find out why. Look up the fund's holdings and manager commentaries found on the fund website. Consult morningstar.com.

Spectacular short-term performance often indicates the fund manager is doing market timing or taking too much risk. It’s great while it lasts, not so great when the fund tanks.

2. The fund performed so well your portfolio needs to be rebalanced.

Excellent performance may leave you with too much in one asset class. You may need to sell at least some of your position in the fund to get your asset allocation back on target. By rebalancing regularly, you will continually be buying low and selling high.

3. You want to capture a capital loss.

If a fund has declined in value because the overall market has fallen, selling for a capital loss to lower your tax bill often makes sense, especially if you sold a winner in the same year. You can either buy the fund back after 30 days, or you can immediately buy a different fund that uses a similar strategy to maintain market exposure.

4. The fund manager changes.

Don’t sell automatically, but make sure you are comfortable with the new manager. How experienced is he or she? Will he or she change the fund’s strategy? Most of the time I don’t sell a fund I recommended just because the manager changed. But I do monitor the fund closely to make sure the new manager does not deviate significantly from the previous manager’s strategy.

5. Style drift sets in.

You want a manager to be disciplined and stay true to the fund’s overall strategy, which is why you bought it in the first place. Actively managed funds of all types—stock, bond and balanced—are especially vulnerable to drift.

There are many ways for a fund to drift. A manager following the herd can lead to your fund becoming a closet index fund that charges higher fees but performs very similarly to its benchmark index. If your fund is no longer adding value, you should look for cheaper or better-performing funds that can deliver what you want.

6. You’re not comfortable with your fund’s investments.

If your fund is investing in illiquid investments, derivatives or other securities you’re uncomfortable with, that’s a legitimate reason to sell. If you want exposure to stocks or bonds, the fund should invest principally in stocks or bonds. Some funds mix in options, currencies, commodities or private securities at the margins. These types of investments can cause problems down the road, especially if the fund experiences large redemptions and has to sell illiquid investments at fire-sale prices.

7. The asset base has become too small.

Small asset bases create problems, especially for actively managed funds with less than $200 million in assets.

A small asset base can lead to large year-end capital gain distributions if some shareholders hold large fund positions. When funds must sell appreciated securities to meet large redemptions, all the remaining shareholders holding the fund in a taxable account suffer. Even in years with flat or negative performance, small funds may find themselves distributing 20 percent, 30 percent or more in capital gains.

Small asset bases also raise the risk of the fund terminating altogether, which can lead to realized gains. If you find out that your fund will soon terminate, it’s usually best to sell it immediately.

8. The asset base has become too large.

Large asset bases can be a problem too, particularly for actively managed funds that invest in smaller companies. As funds grow, it can be difficult to spread bets across many small companies and avoid taking a large ownership stake in any one of them. These funds often must buy an increasing number of stocks, which ends up diluting fund returns and making it more difficult for them to outperform their benchmark index. Look for actively managed small-cap funds with asset bases of $2 billion or less.

9. Expenses increase.

If your fund raises expenses, evaluate what else is available. You may be able to find a fund pursuing a similar strategy for less, especially if you are comparing index funds.

10. You can do better elsewhere.

Even if your fund is doing well, there may be other funds that offer stronger performance or lower expenses.

It pays to regularly check for better investment options. There’s steep competition on annual fees among index mutual funds and ETFs. Many new index funds charge 0.15 percent or less. If your index fund charges 0.50 percent or more annually, or if you’re actively managed mutual fund charges 1 percent or more, look for alternatives at least once a year.

Deciding to sell a fund that isn’t underperforming takes careful thought and analysis. The effect on your overall portfolio and taxes are among the factors you should consider before pulling the trigger.

Paul Jacobs, Certified Financial Planner (CFP), and chief investment officer of Palisades Hudson Financial Group, is based in its Atlanta office. He is a contributor to the firm’s recent book, “Looking Ahead: Life, Family, Wealth and Business After 55.”

Palisades Hudson (www.palisadeshudson.com) is a fee-only financial planning firm and investment manager based in Scarsdale, N.Y., with more than $1.1 billion under management. Branch offices are in Atlanta; Austin, Texas; Fort Lauderdale, Fla., and Portland, Oregon. Read Palisades Hudson’s daily column on personal finance, economics and other topics at http://palisadeshudson.com/current-commentary. Twitter: @palisadeshudson.