Should I sell mutual funds that are performing well or poorly first?

Question

I have roughly equal investments across 4 different high-risk "growth" mutual funds -- let's just assume that other than all being high risk, they're fairly well diversified. Two of the funds are performing well (5-10% growth since purchase), and two are performing poorly (5-10% loss since purchase). So in total, the net gain/loss has been about zero.

Unexpectedly, I need to liquidate half of the investment earlier than I'd originally intended, so I'm forced with a choice of which investments to keep and which to sell.

Is it better to:

1. Sell the well-performing ones! That way I'm not locking in losses from the under-performers.
2. Sell the under-performing ones! That way the good performers can keep gaining.
3. Sell a mix of all 4! Keep the investment "diversified".
4. Do more research: make a bet on the specific sectors the mutual funds cover and either accept losses or keep the growers.
5. It doesn't matter, it's just gambling!

If it helps: my investment style is generally comfortable with risk and a long time-horizon (present cash need excluded), but generally no interest in active micro-managing investments or intensive market research (hence the choice of mutual funds).

Answer 1

In most situations it doesn't matter, but not because it is gambling. The only reason it would matter is if you had a bump in income and are expecting a higher marginal tax bracket in the year you sell. Then maybe it makes sense to sell the ones with the least gains.

Aside from that, the only thing that matters is what you think each stock will do in the FUTURE, not the past. Would you buy each of these stocks at today's prices. That's what you are doing when you keep them. If the answer is no you should sell, regardless of how much gain/loss you have.

"Locking in" is just a game you play in your head that is rooted to the sunk cost fallacy.

Answer 2

Looking at past performance of stocks when making decisions is a common fallacy in stock investment. Past performance is irrelevant. All that matters is whether you expect the stock to raise or fall in the future.

So when you consider which positions to liquidate, the question you should ask yourself is: "If I didn't own this stock already, would I buy it today?" When the answer is yes, you should keep it. When the answer is no, you should sell it.

With managed funds, if they consistently failed to beat the market in the past years, then that might be a sign that it's a poorly managed fund. Which could be a reason not to buy them. But that does not necessarily need to be the case. For example, it might be a fund that specialized in a specific niche industry that didn't perform too well in the past, but you have reason to believe that they could perform better in the future. Which would be a reason to buy it today.

Answer 3

Sell the ones with the high expense ratios

Knowledge of past performance, plus $9, gets you a small coffee at Starbucks but it certainly doesn't tell you a thing about future performance.

However, you don't need a crystal ball to predict the guaranteed total loss you're taking from expense ratio, loads, and other fees.

Bad

Good

Answer 4

None of the circumstances you mentioned affect the answer, which always is: consult your investment policy statement as to the asset allocation that best matches your goals, and buy and sell as appropriate to reach it. Tax considerations are secondary to actually owning what you need to own.

Answer 5

Know what your target mix (typically expressed as percentages assigned to large stock, small stock, bond, international, "income producing") is. Rebalance to maintain that target mix.

Within each of those categories, generally don't sell anything unless you either need cash or see something in that category that you are convinced will perform better than the one you are selling, and you get the best improvement by selling the one you think will perform worst.

Note that this is "believe will perform", not "know has performed." The latter may help shape your beliefs about the former, but is not the sole deciding factor and often not the primary deciding factor.

Note too that there is nothing wrong with just sitting on a single set of investments if you're happy with them and expect them to perform well.

Yes, if you are looking at mutual funds, expense ratio subtracts directly from your gains. Which is one reason index funds do so well; their expenses are often a tenth or less of what actively managed funds charge and the latter don't do sufficiently better to balance that.

Answer 6

Sell the underperforming ones.

1. This makes sense for tax reasons. You have no realized gains that you need to pay taxes on. So need to sell less. Else you'd need to sell enough to cover your cost and the tax expense.

2. Past performance is no indicator or future performance. But cutting losers and letting winners run is pretty basic advice that even Malkiel (Random walk down wall street) recommends. It goes against the intuition to lock in gains, but is simply the sensible thing to do.