No matter how tough things get, you count on your investments to recover from downturns and grow over the long haul. Still, that doesn't mean you should keep putting good money after bad into an investment that probably won't pay off for you in the long run.
So, how can you tell if the stocks and mutual funds you own will ever rise from the ashes? Even after a big drop, selling a doomed investment before it makes its death spiral can salvage at least some money to redeploy more productively elsewhere. Yet if you make the wrong guess, you could find yourself having sold at the rock-bottom low.
Do you have a real loser?
In this month's Champion Funds newsletter issue, Foolish fund expert Amanda Kish reviews her fund recommendations from past newsletters. As you'd expect from a diversified portfolio that includes more than 60 funds, some have done better than the overall market, while others have fallen short of their benchmarks during the recent market swoon. She talks about each fund and whether investors should keep buying or give up and sell.
While you might think that bad losses would be at the top of the list of criteria for making a sell decision, focusing too much on short-term results is the wrong move. As Amanda has said before, there are extenuating circumstances that make selling on a short fuse the wrong move for long-term investors. The most obvious example is following a solid long-term strategy that doesn't pan out in the short run.
Holding off on a sale
Most fund managers aren't any better at market timing than the average investor. If a fund manager's typical strategy is to find beaten-down stocks that show promise over the long run, then the fund may end up buying shares too soon, hurting performance.
For instance, Dodge & Cox Stock (DODGX) has an excellent long-term performance record, showing up in the top 3% of large-cap value funds over the past 10 years and outperforming the S&P 500 by an average of six percentage points per year. Yet its ownership of companies like General Electric
Of course, if you think financials and energy stocks will never recover, then you'll want to steer clear of the fund. If, however, you agree with the fund's basic strategy, its recent results aren't nearly as important as the impact its current decisions will have on future returns.
The right idea
Instead, the three things you should look for when considering a sale are:
Inexperience. Have your managers gone through tough times before? Do they have the tenacity and determination to succeed -- and the knowledge to avoid common bear-market mistakes? If not, why should you pay for their education -- and put your money at risk?
Bad or no track record. Anybody can have a good year or two, but if your manager hasn't found a way to put together a great long-term track record -- despite the occasional bump in the road -- find another who has.
Inconsistency. The best investors find an area of expertise and stick with it. Warren Buffett, for instance, eschewed technology stocks like Microsoft
(NASDAQ:MSFT)and Dell (NASDAQ:DELL)in the late 1990s because he claimed he couldn't understand them. Similarly, you wouldn't want your manager in a financial sector fund jumping ship to buy hot stocks like McDonald's (NYSE:MCD)and Genentech (NYSE:DNA)-- even though they've done much better than financials lately, they're not within your manager's circle of competence.
You can see how these factors play out with actual funds by reading this month's Champion Funds newsletter. Amanda points out beaten-down funds that still deserve your money, as well as some that she's keeping a close eye on to see if it's time to get out.
Quitting on an investment never feels good, especially when you've lost money. But protecting your portfolio is too important. When an investment shows no signs of ever recovering, do the right thing, and get out with whatever you can. You'll usually end up much better off than if you'd held out hope in the face of long odds.
For more on buying and selling, read about:
Fool contributor Dan Caplinger has sold some stocks, but he's sticking with his mutual funds. He owns shares of General Electric. Microsoft and Dell are Motley Fool Inside Value selections. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy never gives up on you.