While no one goes out of the way to find and invest in a bad fund, many people hold onto bad funds far longer than they should, enduring pathetic returns or awful treatment year after year. And since the fund world is not a meritocracy — where only funds that deserve to survive actually get to stick around — it’s important that you not fall in love with a bad fund.
Sure, “bad funds and the investors who love them” sounds like a poor episode of Oprah Winfrey, but it’s a real-life problem for many investors, where the proof lies in the billions of dollars that remain in thousands of undeserving funds.
Although it is unreasonable to dump a fund after a bad quarter or two, there is no reason to stick with a fund whose yo-yo performance, mediocre returns or downright awful behavior is unacceptable. If you have used any of the following excuses as a reason to stay in a fund that has treated you poorly, it’s probably time to cut the alibis and the fund from your portfolio.
“I’m too busy.” Inertia is your enemy. Yet people who dislike change and hate to own up to making mistakes can wind up holding a bad fund for years. Remember, a fund can be consistently awful without putting up the cataclysmic numbers that would panic you into bailing out. If you have too little time or interest to monitor your funds, don’t be stunned when you wake up to lackluster gains.
“It was good to me once.” Possibly the most dangerous of excuses, this is a common comment when investors have “fallen angels” — former star funds — in their portfolio. But this is a mutual fund, not a marriage partner. What the fund has done for you in the past is a lot less important than what you believe the fund can do in the future. If recent past performance is a far cry from the glory days, don’t hang on to the past hoping it will repeat itself. Decide whether you would buy this fund anew today; if not, consider divorcing yourself from the fund.
“It’s really not so bad.” Plenty of funds provide positive returns and fool investors into thinking that everything is copacetic. But if you are in the worst fund in an asset class, you could find yourself making nickels when the average fund is delivering dimes. If you think a fund “could do a little better,” don’t disregard your concerns. Crunch the numbers to see whether you are worrying needlessly or whether the fund really is failing to meet your expectations.
“I’m waiting to get back to break-even” or “I’m waiting to earn back the load I paid.” In either situation, you could wait forever. Even if you recoup your losses, you might be better off getting out now and putting your money on a faster horse that speeds your recovery. It takes courage to acknowledge investment mistakes and cut one’s losses.
“It can’t stay bad forever.” Oh yes, it can.
This is “the gambler’s fallacy,” the belief that if a coin flip comes up heads four straight times, there is either a hot streak or a reduced chance that it will happen again. In fact, each flip remains a 50-50 chance. Not every fund turns around.
“My broker hasn’t said to sell.” You want your broker or financial adviser to give you the emotional discipline to stay put and see the long view when the current market makes you jittery. But that doesn’t mean abdicating the selection process or relying entirely on the adviser.
“Everything looks fine in the fund’s reports.” Of course it does. When a fund is terminally mediocre, its manager or company president puts the shine on the sewage. If the fund’s statements about prospects and performance have never appeared in your account statements, then the fund may not be giving out the most accurate picture of what’s going on.
“It’s still got a good rating from Morningstar.” This is a cousin to “Money magazine (or one of its competitors) said this was a fund to hold for the next five years.” Ratings and articles are snapshots, based mostly on past performance.
Oftentimes, they are based on long-term numbers, so that a fund with a few glorious years can live on its reputation for a long time, even after performance starts to falter. Past performance isn’t going to make your money grow over the next few decades, so ratings and past triumphs should not be the sole reason to hang on to a fund that clearly has faltered.
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Chuck Jaffe is the mutual funds columnist at The Boston Globe. This is an excerpt from “Chuck Jaffe’s Lifetime Guide to Mutual Funds: An Owner’s Manual” (Perseus Books). He can be reached by e-mail at jaffe@globe.com or at The Boston Globe, Box 2378, Boston, Mass. 02107-2378.
