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The Globe & Mail Misleads On When To Sell


The Globe & Mail Misleads On When To Sell

Contributed by: martingale

Commentary The Globe & Mail is running a story on when you should sell a mutual fund that has been underperforming: The article investigates several funds which have "underperformed" as a way of illustrating how you might analyze your own funds. There are several gross errors in this analysis that investors ought to be aware of. This article suggests that investors who "buy and hold forever" are somehow fools--which may just be an attempt to fool you into churning your money, earning transaction fees for companies that advertise in the Globe & Mail.

Standard investment theory has it that you should periodically rebalance your assets. That means if something has declined in value you should add more money to it. But, flying in the face of that conventional, standard advice we've got the financial press promoting the idea that you should sell your losers. Let's see what's gone wrong.

First, and most blatantly, the article never mentions fees. The most common reason why a fund would underperform its peers is that its manager is pocketing more of your money. Actively managed funds generally have fees ranging from 2 to 5%. Given that the expected return of the stock market is only 8-10% the manager is going to pocket somewhere from 20 to 50% of your profits.

Second, the article analyzes the past performance of various funds by looking at their overall performance and their consistency: "short-term momentum that suggests a rebound". Nobody should ever make an investment decision based on short-term factors, nor should anyone ever consider past performance: past performance is no indication of future returns.

There's an even worse problem with this analysis: The article seems to suggest that a fund with a more "consistent" history might have a better return in the future when it says you should "compare your fund to others in the same category in terms of long- medium- and short-term performance and on year-by-year consistency". What does determine the performance of a fund is whether it holds higher or lower risk assets. Riskier assets have a better return, but they are not consistent (that's the definition of "risk" by the way). If you want to pick a fund with a higher return pick the one that has been the least consistent--the opposite of what Carrick says.

Now you might not want to take a risk (such as if you are retired and you need the money) but you should certainly understand this principle. Carrick seems to be suggesting that you can find higher return, lower risk funds and there is absolutely no such thing. The danger here is that if you follow Carrick's advice you may sell your "inconsistent" assets when they are low. Investors who fall in this trap will likely wind up buying a riskier fund just after it has had a good run up (and it is high) and then turn around and sell it when it has a few bad years (and is low). The idea is to buy low and sell high, so this is exactly backwards.

Finally, I have to take issue with one statement: "If you invest $1000 and lose 25 percent, it takes a 33-per-cent gain just to break even." All securities are always fairly priced. A fund that has fallen by 25% is now priced at a fair value--even if that is a loss for you. Thinking about "breaking even" in this case is just the wrong way to look at it. The money you used to have in the fund is gone; your current investment in the fund is as "even" as it ever was or will be.

Here is some advice on when to sell funds: If you are paying a fee more than 1% you absolutely should sell; if you are paying more than 0.50% you should seriously think about selling. If you are paying less than that you should sell when you need the money, or if you need to rebalance.

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