Find Out If the Feeling’s Still Mutual
When reviewing a mutual fund’s performance, experts suggest answering one question: “Would I buy the fund again today?”
But that can be tough to answer. Years pass and investors forget the precise reasons they bought a fund. Indeed, the reason a fund looks good in the first place can be a low minimum initial investment, advice from a rich brother-in-law, the need to diversify and other reasons not tied to performance.
Yet every few months, newspapers and magazines review the quarterly results of mutual funds and investors make hold or sell decisions based almost entirely on current numbers.
“You buy a fund for a reason . . . and sell it because it is not delivering what you expected,” says Monte Avery, who manages the North Dakota-based Integrity Fund of Funds. “If you have a firm criteria and know what you want a fund to do, you take the emotion out of your decisions and make it easier to say whether something still belongs in your portfolio.”
With that in mind, investors should write down the reasons they bought a fund. The best time to do that is when the fund is purchased; your list of motivations for buying the fund becomes the first thing in the file used to hold monthly statements. (If you already own the fund, try to reconstruct your reasoning.)
“There is a discipline to making a selection and writing down the reasons for it,” says Robert Markman, who manages the Markman Multi-Funds, a fund-of-funds family. “By knowing exactly why you bought a fund, you avoid the tendency to gloss over everything but performance once you own it.”
Over time, your selection criteria, asset allocation, feelings about the stock market and needed returns will change. So will a fund’s performance and possibly its style and manager. Writing down your reasons for buying a fund will help you see the factors that colored your judgment and makes it easier to determine if you would buy the fund again today. To effectively review your fund selections later, you will want to answer these questions in writing when you buy:
* How did I hear about the fund? You got a tip from a friend, advisor, magazine or newsletter. Over time, newsletters change their “buy” lists, your sister could dump that rich brother-in-law and you might drop your subscription, financial advisor, or both.
If performance is disappointing, you should consider whether you still have confidence in the initial referral. If not, chances are you would not buy the fund again.
* Specifically, what stands out about its performance? Perhaps the fund is consistently in the top 20% of its peer group. Maybe it has a good rating from a service such as Morningstar. Be as clear as possible about what performance traits you like; if the fund loses that status, then it has lost some of the luster that first attracted you.
* What are my expectations and benchmarks for this fund? You might want to beat the market, or to beat nine out of 10 funds in the same asset class. Or you might want a simple 8% annual return. Either way, you want a fund that meets your goals, so lay out those expectations in terms of both absolute returns and performance against peers or benchmarks.
A fund that consistently meets your expectations is probably worth holding, even if it lags the market or no longer sits at the top of the performance charts.
* What will a bad year look like? Predict the worst-case shortfall in a market downturn. (Short cut: Put a negative in front of the return during the fund’s best-ever gain.) This helps you decide whether a fund is too volatile or risky for you; later on, it tells you if a slump is a big disappointment or within the realm of your expectations.
* What characteristics make it attractive? Low minimums, no sales or marketing fees or availability through a specific network can influence your thinking. They limit the number of funds you select from. Yet, over time, funds change policies. Your needs and philosophies change and expand too. If the characteristics that once drew you to a fund are no longer important, it becomes easy to justify a move to a better-performing competitor.
* What role does this fund play in my portfolio? Say you bought a fund to diversify. But years pass and you buy other funds. Now, a fund picked to add, say, international flavor is actually one of several funds serving that role. Or perhaps a fund has changed its style and now buys large-company stocks instead of the small firms you purchased it for. If returns are dragging and the fund no longer serves the purpose for which you bought it, there may be no reason to hold on.
* Are there any other attractions to this fund? If the manager is a star, the fund buys a hot type of asset or if there are any other significant selection factors, this is where you list them. Over time, the manager may leave and the assets may fall out of favor. If these factors no longer apply, you might not buy the fund again.
Charles A. Jaffe is mutual funds columnist at the Boston Globe. He can be reached by e-mail at jaffe@globe.com or at the Boston Globe, Box 2378, Boston, MA 02107-2378.
