The dilemma faced by some mutual fund investors on when to sell off an investment made in a fund often seems greater than the one they face while choosing a fund to invest in. The problem is that most — if not all — of us, who are active and involved investors, have a bias for action. We equate being good investors with doing something, often anything. Unfortunately, this translates in practice to not just buying more funds than we need, but also to be ever ready to sell.
I frequently get questions from trigger-happy investors who are raring to sell a fund. There are generally three types of reasons they give for wanting to do so. One, they’ve made profits; two, they’ve made losses; and three, they’ve made neither profits nor losses. That’s not a joke. At least, it’s not intended to be. Typical statements go something like this: “Now that my investments have gone up, shouldn’t I book profits?”; “This fund has lost a bit of money recently, shouldn’t I get out of it?”; “The fund has neither gained nor lost. Shouldn’t I sell.” Basically, investors who have a bias for continuous action can create logic for taking action out of any kind of situation.
The worst cases are those where investors want to sell a fund because it has done well, but not as well as its own past or its peers. Investors are willing to bail out of a fund that has done well for years on the basis of slight underperformance for a few months. The other day, I had a question from an investor who wanted to redeem a fund which, after six years of outstanding performance had given a ‘mere’ 60 per cent gains over a period when the top performing peers had done 70-90 per cent.
The problem is that investors’ actions while choosing a fund often mirror those while selling it. If you’ve chosen a fund because it was doing well for six months, then you’ll probably feel like selling it if it underperforms for three months and move on to another one, which has done well for six months. This doesn’t work. Investors in equity funds should choose one fund for sustained good performance over several years. As for selling them, the most logical reason for doing so would have more to do with your own finances. Are the financial goals, for which you were saving, fulfilled? Then, by all means, you should sell off and redeem whatever money you need.
You should be a lot more circumspect, as far as getting rid of a fund and switching to another because it has started doing badly. The reason is that unless their management changes, funds that have a long history of good performance don’t suddenly become bad. It takes certain qualities for a fund manager to do well over years and those qualities do not vanish overnight. Everyone can have ups and downs and have bad phases, generally because one or two calls went wrong. In my years of analysing funds, I cannot recall a case in which someone was a good fund manager for years and then permanently became a bad one. And vice versa.
What this means is that, as long as the fund management remains the same, and as long as the fund is a diversified one (not a thematic one whose theme has gone wrong), it is better to be patient than to be trigger-happy.
This column first appeared in November 2009