It’s Time to Devise a Strategy for When to Sell

Consider last week’s attempted coup in the Soviet Union and the short-lived stock market turmoil as a wake-up call: If you don’t have a strategy for determining when to sell your stock mutual funds, now might be a good time to formulate one.

This isn’t to say that you should have bailed out because of the Soviet crisis; in fact, many advisers were recommending that you sit tight through the worst of it. But it’s better to have some guidelines in mind for exiting in a rational manner. That way, you don’t leave yourself vulnerable to panicking along with the rest of the investment crowd.

Before making any rash moves when the next crisis hits, consider the following questions:

* Are your holdings risky enough to sell? Stock funds are not created equal. Some are conservative choices designed to pull through all types of market environments. In particular, balanced, asset-allocation and income portfolios typically have significant bond or cash investments that help dampen the fluctuations of their equity holdings. They’re best left alone.

* Are you invested for the long haul or just a couple of years or fewer? The longer your horizon, the better your chances of recouping setbacks. Even the crash of 1987 is starting to look like a blip on charts showing the market’s direction over several decades.

* Are you prepared to pay taxes or transaction costs? Unless you’re holding mutual funds within an IRA, annuity or some other retirement plan, you will trigger a taxable gain or loss each time you sell. “The problem with market timing is that it does generate trades, and trades cost money,” says Gerald Perritt, editor of the Mutual Fund Letter in Chicago. Similarly, you might face some sort of redemption charge, backed load or switch fee, depending on the fund you own.

* When and under what circumstances will you buy back in? This is the chief difficulty of a short-term timing strategy: For the approach to work, you must reinvest at a lower price than you sold at. That’s easier said than done, especially when you consider the swiftness with which the market sometimes moves. After the Persian Gulf War began favorably for the allied forces, the Dow Jones industrial average surged 115 points on Jan. 17--in a single day offsetting the decline of the previous month.

Even some professional market timers suggest that investors not try to trade on a short-term basis. “I generally feel that novice investors should hold their mutual funds,” says Cedd Moses, president of Portfolio Advisory Services, a Los Angeles money management firm. The problem, he says, is that a timing strategy requires you to keep a close eye on the investment climate and to spend a lot of time back-testing various indicators to see if they have predictive value.

Besides, a buy-and-hold posture can be justified by the market’s long-term performance. “I think that risk is high and the potential gains are low on a short-term basis,” says Moses, who turned bearish in early June. “However, I still feel that in the long run the market will continue to work its way higher.”

Nevertheless, if you don’t feel comfortable staying invested in stock funds when the direction appears down, you might try following an objective buy-sell discipline such as a moving average. This is merely a plotted line that smoothes out a fund’s daily price fluctuations so that you can better spot the underlying trend. When the fund’s actual price falls below its moving average, that’s a bearish signal. Conversely, when the price moves above the average, that’s positive.

With this type of trend-following mechanism, you will never buy at the top of the market or sell at the bottom. The intent is to capture most of a rally and avoid most of a decline. One challenge is deciding how long of a moving average to follow. Lengthier averages, particularly those spanning several months or more, will result in relatively few switches, with the obvious danger that your fund might drop quite a bit before a sell signal is generated. With shorter averages of a few days or weeks, there’s the risk of getting whipsawed.

Or, you might try a simple mental stop-loss. Here, you resolve to sell your fund after it falls by a certain amount--say, 10% from its recent high price. Again, the idea is to reduce your losses to a moderate level, but there are problems.

“With mechanical stop-loss procedures, you can get decimated from being whipsawed in and out,” says Norman L. Yu, a Newport Beach money manager who figures stop-losses work only about 20% of the time. Throughout the Soviet turmoil, Yu remained bullish on equities. Based on what he perceives as a lingering shortage of common stock relative to demand, he figures the Dow could rally to 3800 by June 1993.

As yet another selling discipline, you might try setting a target asset allocation mixture and adjusting it periodically as your different fund holdings rise and fall. For example, suppose you have 40% of your money in equity mutual funds and 60% in bond portfolios. If the stock market then dropped and bonds rallied to where you had a 35%-65% combination, you would then buy more equity shares and sell some bond holdings to get back to the original combination.

Critics point out that such an approach may lead to mediocre results, but at least it’s one way for conservative individuals to maintain some stock market exposure and feel comfortable about it. “By reallocating, you sell off what has risen in value and buy more of what has declined,” says Perritt. “It forces you to behave the way you’re supposed to.”

Other Reasons to Sell

International political turmoil, domestic economic problems, a pricey stock market: These are the dark clouds that cause investors to abandon equity mutual funds. But there are other reasons for selling that have nothing to do with the broad investment picture, as when your fund undergoes a fundamental change. Red flags include the following:

* The imposition of new or higher sales charges. A mutual fund might add an up-front or back-end sales charge so as to enlist brokerage help in attracting investors. It’s even more common for a fund to impose a 12B-1 fee--an annual charge that can really add up over time. If you see these levies coming, you might want to switch to another fund group.

* Higher annual expenses. All mutual funds make shareholders pick up the tab for management, marketing and certain other costs. These ongoing charges are measured by the fund’s expense ratio. When this number rises sharply from year to year, that’s a worrisome sign.

* Changes in management. It’s not unusual for portfolio managers to resign, transfer or get fired. When this happens, the replacement could be an inferior manager (although the reverse is also possible). Personnel transitions are less disruptive when the fund is run by a team or committee.

* Changes in investment objectives. If your value fund starts buying a lot of volatile growth stocks, it might be time for you to sell. “This is a signal that management has panicked and has had little success doing what it set out to do,” says Gerald Perritt, editor of the Mutual Fund Letter in Chicago.