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Dump that chump fund
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August 27, 1998: 9:58 a.m. ET
If it's just not working out, you may have to go out and find a new fund
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NEW YORK (CNNfn) - You've been through joy and heartache, richer and poorer, sickness, health and bear markets. But someday you may decide things just aren't working out and it's time to break up -- with your mutual fund.
Sure, you'll remember the good times, like the year you first met when the computer sector climbed higher and higher and you and your tech fund went hand in hand with it.
But determining when it's over and when you need to find something new is an inexact science, especially in a culture that tells you to stick with your fund no matter what the circumstances -- otherwise known as the "buy and hold" strategy.
Before calling it quits, take a look at what has changed in your relationship. Outside help will allow you to do this. When you buy a fund, have a benchmark in mind you can use to evaluate its performance.
For example, with a micro-cap fund you might want to use the Russell 2000, a widely-known index used to measure the performance of U.S. small company shares.
Check how your fund has performed over the past 12 months, three years and five years, said Roy Weitz, editor of FundAlarm, a website dedicated to helping people end destructive fund relationships.
As a double-check on the benchmark, compare how your fund has performed in comparison to its peer group -- funds which have a similar investment approach.
"If your fund has trailed its benchmark for 12 months, three years and five years, along with its peer group, then you have some pretty good reasons for selling," said Weitz.
Drifting apart
It's hard enough to keep the love alive with your mutual fund without someone else getting in the way of your relationship. Namely, your fund manager.
As an investor, you usually seek out funds who share your philosophies. For example, if you love 'em large, you go out and buy a large cap fund.
However, your fund manager might get an urge to stray, moving into investments that would appear to be outside of the fund's guiding strategy. This is known as "style drift."
Despite what you may believe when you buy a particular fund, the manager has an incredible amount of leeway as to where he can invest your money.
For instance, an international fund doesn't necessarily have to invest all of its assets overseas. A growth fund can have significant amounts of its holdings in cash.
The unwary investor can be the last to know her fund is cheating. Keeping on top of this requires a healthy amount of distrust of your fund manager. Fortunately, the Internet allows you to keep up on their most recent allocations.
Check up on your fund's holdings here
This is all part of an evaluation process that should start almost immediately after you buy into a fund, but that doesn't mean you should give up on a fund so quickly.
John Markese, president of the American Association of Individual Investors, advocates looking at your fund each quarter, keeping a particular eye on its peer group.
If your fund isn't keeping up with similar funds you shouldn't necessarily change your investment strategy.
"You're staying within the group," said Markese. "You're just jumping over to another fund that's in the same peer set." Therefore, if your mid-cap fund is lagging behind, you'll want to look at another mid-cap fund which has been handling the market more effectively.
When you're the one left behind
Sometimes the choice of dumping a fund isn't your idea. Instead, you may someday be the one who's left behind when the fund manager who has made your life so wonderful decides to move on.
You may think nothing will change. Your fund will have the same strategy and the new manager probably worked with the old one and was familiar with his style. Things will pick up where they left off. Right?
Unfortunately, fund managers aren't so interchangeable, said Robert Tull, certified financial planner at R.W. Tull and Associates, based in Chesapeake, Va.
"They don't all think the same. They went to different schools and worked in different businesses with different backgrounds," said Tull.
But a manager change doesn't automatically mean you should look at other funds unless the performance of the fund consequently suffers.
Rising fees are another reason you may want to reevaluate your fund. Occasionally, your fund company may decide to pay its managers more, passing the extra cost onto you.
Additionally, they may step up the payments they make to compensate investment professionals for selling and promoting their mutual funds. These costs, known as 12b-1 fees, reduce the overall return you get on your investment.
The desire for a change may not even have anything to do with any external causes. Instead, it may be due to some change within yourself.
If you feel the need to invest more conservatively, you might move away from the more hair-raising stock market and into more fixed-income investments.
If you are approaching retirement, you could consider switching investment styles in order to preserve capital, moving from growth funds to value funds.
Barring any of these factors, think long and hard before making any quick fund changes. Investing is not something which should be guided by whims.
"If it wasn't an impulse purchase and it wasn't the result of high-pressure sales tactics, I feel you should allow at least 12 months of poor performance before the fund even hits your radar screen," said FundAlarm's Weitz.
The only alternative would be to play the field, explained Weitz, shifting from fund to fund in an unending search for happiness.
No one has ever come up with a foolproof way for switching funds successfully over a long period of time, said Weitz, although he wishes he knew how.
"If I did have a successful timing system (I would) take out an ad on every financial website and every major financial newspaper and prepare to become a billionaire. It wouldn't take long."
Still, while you may be ready to call off your relationship with your fund, the fund firm may cling jealously in the hopes you (and your lovely assets) will reconsider.
Some mutual funds have sought to hold on through the use of redemption fees. These fees are charged to investors who leave a fund within a particular amount of time, usually six months, and can run as high as 1 percent.
But hopefully, you'll one day find yourself in a mutually-fulfilling fund relationship that will last a long time. This, said Weitz, is the best way.
"As boring as it seems, buy and hold is still the best strategy, assuming it is based on sound allocation and careful buying decisions."
-- by staff writer Randall J. Schultz
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