Bad Investments to Get Rid of Now

With the stock market on track to lose 40% or more in 2008, you won't find many positive performers in your portfolio this year. But that doesn't mean you shouldn't give all your investments a hard look, to see if they deserve to stick around in 2009 and beyond.

In fact, it's even more important that you take a critical view of your portfolio right now. While good years may give you the luxury of letting some underperformers slide, the top priority of preserving your capital demands that you not let bad investments suck away any more of your hard-earned money than absolutely necessary.

Looking at performance
Deciding when to get rid of a particular stock depends on a number of factors. Although strong financial results always make a company more attractive, financials alone don't necessarily mean that a stock will post market-beating returns in the future. Look no further than the energy sector to see some good examples of that:

Source: Yahoo! Finance.

As you can see, strong profitability isn't enough to sustain stock prices. You have to follow through and continue to build on past profits. In the case of energy, slowing growth prospects and falling oil prices promise to squeeze net income going forward, strongly suggesting that current profit numbers are one-time windfalls.

When to sell a mutual fund
Similarly, when you're looking at your mutual fund portfolio, past performance is just one element in determining whether a fund's worth holding. You also have to look at a host of other factors, including the fund's management experience, investing style, and any steps the fund plans to take to improve results going forward.

For instance, the most recent issue of our Motley Fool Champion Funds newsletter includes a couple of sell recommendations for past newsletter picks. In both cases, the funds in question have had good performance records in the past, with below-average expense ratios and reasonable stock picks.

Several factors persuaded lead advisor Amanda Kish to sell:

• Inexperienced management. Both funds had relatively new managers at the helm, both of whom didn't protect investors from the past year's downturn.
• Underperformance compared to peers. While losses are to be expected, you shouldn't have to lose more than your tracking benchmark or other typical funds in the same category. Both of these funds lagged both benchmarks and peers badly in the last year or two.

Yet perhaps the most important reason for selling these funds is that changing market conditions ran contrary to the reason Champion Funds picked them in the first place. That's why it's so important to write down your reasoning for buying a particular stock or fund right when you buy it. That way, you can look back at your explanation, and if things have changed, then you'll know you need to reconsider your pick.

It's never easy to get rid of a stock or mutual fund, especially after you've done a lot of work researching it. Yet when markets aren't dishing out big gains year after year, you can't afford to have any of your investments drag down your overall performance. As hard as it may be to cut off badly performing investments, doing so will help you maximize your profits over the long haul.

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