Lately, you've probably heard a lot of people tell you not to think about selling your mutual funds. After all, they argue, with the markets down, panic-selling now could mean taking a big loss -- one that could remain permanent, if stocks rebound before you reinvest the proceeds.
But as a fund investor, you still need to remain vigilant. With thousands of funds available, you won't always pick the best one for your goals. And even if you do manage to find a great fund, it won't always stay great forever.
How will I know?
The same factors that help you choose a good actively managed mutual fund can help you decide when it's time to get out. As Foolish fund expert Amanda Kish has explained in her Champion Funds newsletter, when scouting out funds for your portfolio, you should look for reasonable costs, experienced fund leadership, consistent outperformance, and a management team that's willing to put its own money into the funds it oversees.
Conversely, if you've already invested in a fund and one or more of these favorable characteristics disappears, be wary. When extraordinary managers leave the fund, their successors aren't guaranteed to maintain the fund's winning ways. Several years of underperformance can mean that the fund's management team has lost its edge. Rising costs can indicate internal problems with a fund company -- or, if accompanied by outflows of capital, they can suggest a loss of efficiency.
Walking in a legend's shoes
As an example, consider Fidelity Magellan, the flagship mutual fund formerly run by fund superstar Peter Lynch. Lynch's "buy what you know" philosophy led him to buy companies like Yum! Brands' (NYSE: YUM ) Taco Bell unit, Apple (Nasdaq: AAPL ) , and Pier 1 Imports (NYSE: PIR ) at opportune moments, and Magellan earned nearly 30% annually during his 13-year tenure. The next two managers that followed Lynch also managed to outperform the S&P 500 index, albeit not as spectacularly.
For Robert Stansky, however, the story would be different. Taking over Magellan in 1996, Stansky was the first Magellan manager who failed to match the benchmark index. One criticism that Stansky faced was being a "closet indexer" -- managing the fund so that its return would never be much different from the S&P 500.
But Stansky also made some bad calls. In the fund's 2002 semiannual report, Stansky admitted to having underweighted consumer-staples stocks like Anheuser-Busch (NYSE: BUD ) and Procter & Gamble (NYSE: PG ) in favor of Home Depot (NYSE: HD ) and Tyco International (NYSE: TYC ) . The latter two companies lost more than half their value during the bear market of 2000-'02, while Anheuser-Busch rose about 40%. As a result, many of Magellan's shareholders jumped ship, and with the fund closed to new investors during much of Stansky's tenure, assets under management stayed stable.
When things change
As a fund investor, you have to be on the lookout for changes within your funds. Some events, like Lynch's departure from Magellan, are so obvious that you can hardly miss them. But changes don't have to be as conspicuous as a superstar's exit to warrant casting a more critical eye toward your fund choices.
During good times, it's easier to give fund managers some leeway -- even if you're not outperforming the market, you're still usually making money. But as times get tougher, it's more important to know when you could do better somewhere else. If your mutual fund stops performing for you, don't hesitate to find another that will make you more money.
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