4 good reasons to sell a mutual fund

If you have mutual funds in your 401(k), take a look under the hood. Consider selling a fund if it's underperforming or not doing its job.


When's the last time you checked on the mutual funds in your 401(k) account?

OK, maybe that's like the dental hygienist asking you about the last time you flossed — only the fastidious among us really keep up with this stuff. But if you haven't looked in a while — especially if, say, you gravitated toward the funds that came first alphabetically when setting up your account — maybe it's time for a checkup.

If you hold a portfolio of index funds, don't worry. As long as you're invested in the slices of the market you want, those funds are doing their job. But if you hold actively managed funds — meaning those with someone picking investments to achieve a certain goal — it's worth checking in to see if any red flags have cropped up.

If you come across one or more of the following four concerns, you may want to consider selling your fund in favor of something else that suits you better.

Performance is poor

This seems intuitive: If your fund's returns aren't up to snuff, give it the boot, right? Not so fast.

"Every investor has a bad few years," says Morningstar's director of manager research Russ Kinnel. "If you used that standard, you'd have dumped Warren Buffett."

Investors need to put funds' returns in context, Kinnel says. Say you own a fund that invests in undervalued small-company stocks that's lost 15% so far in 2020. That might be a sell signal in some years, but not this year, given that such funds have surrendered nearly 21% on average.

To assess a fund's performance, compare its long-term returns to those of peers. Focus on year-to-year performance rather than homing in on 1-, 3-, 5-, and 10-year returns, which can be skewed by recent results.

Show the door to funds that consistently lag behind their peers and benchmark indexes. That's often the S&P 500 for large-company U.S. stock funds, or the Russell 2000 for funds tracking small-company stocks.

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It's not doing its job

You buy a mutual fund to fill a certain role in your portfolio. If a fund isn't doing its job, either due to a change in strategy or failure from the manager, it may be time to sell.

"It's not unusual for funds to change their strategy," Kinnel says.

Maybe you bought a fund that originally focused on companies of all sizes but now focuses only on midsize companies. Maybe a fund you own that used to invest in U.S. stock has started investing in international companies. In cases like those, it's worth assessing whether your fund is still doing what you want it to do. Consider selling if it isn't, Kinnel says.

Similarly, be wary of funds that don't live up to their mandate. Say you bought a conservative portfolio of high-quality, blue-chip stocks. Fund managers will tell you that you should expect such a fund to trail peers and major stock indexes during a raging bull market — when riskier fare tends to perform better — but also to hold up better than peers during bear periods. So if a bear hits and your fund sinks right along with the market, consider making a change.

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Leadership has changed

You needn't sell if your mutual fund comes under the leadership of a new manager, but it's still a reason to pay attention. Even if a mutual fund company says the fund will stick to a time-honored strategy, a new manager may want to shake things up, which could affect the complexion or performance of the fund.

Sometimes a change is obvious. The Artisan International Small Cap Fund became Artisan International Small-Mid when Rezo Kanovich took over in late 2018, reflecting a shift in the portfolio from small-company stocks to a mix of small and midsize names. If you were willing to take the step up in size, you were rewarded: The fund has done well so far after a few lackluster years under the previous manager.

But that's not always the case. Just take a look at how the Fidelity Magellan Fund has fared since legendary manager Peter Lynch called it quits in 1990. Spoiler alert: It lagged badly behind the S&P 500.

It's fallen prey to 'asset bloat'

When it comes to managing mutual funds, investing sage Notorious B.I.G. said it best: Mo' money, mo' problems. When a mutual fund accumulates an enormous amount of investor dollars, it becomes more difficult for a manger to stick to a winning strategy. This phenomenon is called "asset bloat." In other words, investors should be wary if a fund they own is getting too big.

Asset bloat is especially problematic for funds that hold small-company stocks, since managers who want to avoid taking huge positions in small companies tend to start investing in bigger companies, shifting the portfolio into mid- or large-company stock territory.

For large-company stock fund managers, a glut of cash tends to make the funds look more like the indexes they're supposedly trying to beat, as the managers — unable to concentrate billions of dollars in just a few key holdings — are forced to spread their money among more and more stocks as assets grow. 

Behaving like an index isn't necessarily a bad thing for a mutual fund, but a fund designed to do that will come much cheaper than one run by an active manager. There's no reason to overpay. 

If your fund is growing larger compared to peer funds, make sure the fund hasn't significantly changed its strategy or added a bunch of new positions. When Peter Lynch left Magellan, the fund's assets had grown from $18 million to $14 billion. By early 2000, assets ballooned to more than $100 million. In the years that followed, the fund had trouble keeping up with the S&P 500.

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