Many financial advisors and academics do not recommend selling stocks and mutual funds when prices are tumbling, during bear markets. If you can just hold on through thick and thin, they argue, you are likely to enjoy returns better than any other asset class, over the long run; an average annual yield of 6.5 to 7% after inflation, according to Professor Jeremy Siegel's, "Stocks for the Long Run." However, there are occasions when selling a mutual fund might be warranted; buy and hold is not forever. Here we look at the top eight reasons for selling a mutual fund.

Tutorial: Mutual Fund Basics

Portfolio Rebalancing
Over time, trends in financial markets might cause asset allocations to diverge from desired settings. In other words, some mutual funds can grow to a large proportion of the portfolio, while others shrink to a smaller proportion, exposing you to a different level of risk.

To avoid this outcome, the portfolio can be rebalanced, periodically, by selling units in funds that have relatively large weights, and transferring the proceeds to funds that have relatively small weights. Under this rule, the time to sell equity mutual funds is when they have enjoyed good gains over an extended bull market and the percentage allocated to them has drifted up too high. (To learn more, read Rebalance Your Portfolio To Stay On Track.)

Mutual Fund Changes or Mismanagement
Mutual funds might change in a number of ways that can be at odds with your original reasons for buying. For example, a star portfolio manager could jump ship and be replaced by someone lacking the same capabilities. Or there may be style drift, which arises when a manager gradually alters his or her investing approach over time. (For more insight, check out Style Drift Can Hurt Mutual Fund Returns and Should You Follow Your Fund Manager?)

Other signals to move on include an upward trend in annual management expense ratios (MERs) or a fund that has grown large, relative to the market. If the fund has grown large compared to the market, managers could have difficulty differentiating their portfolios from the market, in order to earn above-market returns.

Investor Growth
As you gain experience and acquire more wealth, you may outgrow mutual funds. With greater wealth comes the ability to buy enough individual stocks, to achieve adequate diversification and avoid MERs. With greater knowledge comes the confidence to do it yourself, whether it is actively picking stocks or buying and holding market indexes, through exchange-traded funds (ETFs).

Life Cycle Changes
Although stocks historically have been the best investments to own over the long run, their volatility makes them unreliable vehicles in the short term. When retirement, children's post-secondary educations, or some other funding requirements approach, a good idea is to shift out of stock-market funds into assets that have more certain returns, such as bonds or term deposits, whose maturities coincide with the time that the funds will be needed. (To learn more, read The Seasons Of An Investor's Life.)

Sometimes, investors' due diligence is incomplete and they end up owning funds they otherwise would have not purchased. For example, the investor might discover that the fund is too volatile for their tastes, a closet-index fund with a high MER, or invested in undesirable securities.

Portfolio errors might also have been committed by the investor. A common mistake is over-diversifying with too many funds, which can be difficult to keep tabs on and can tend to average out to market performance (less fund fees).

Another common misstep, is to confuse owning a large number of funds with diversification. A large number of funds will not smooth out fluctuations, if they tend to move in the same direction. What's needed is a collection of funds, of which some can be expected to be up, when others are down.

Shift out of mutual funds to rebalance your fixed portfolio allocations, by using a flexible or opportunistic approach. A common valuation yardstick is the price-earnings ratio (P/E ratio); for U.S. stocks, it has averaged 14 to 15 over time, so if it rises to 24 to 26, valuations are overextended and the risk of a downturn is elevated. (See P/E Ratio: Introduction, for more.)

Something Better Comes Along
Investing legend Sir John Templeton, advised selling whenever something better came along. In the mutual fund realm, some funds can come onto the market with innovations that are better at doing what your fund is doing. Or, over time, it may become apparent other portfolio managers are performing better, against the same benchmarks.

Tax Reduction
Mutual funds held in taxable accounts, might be down substantially from their purchase price. They can be sold to realize capital losses that are used to offset taxable capital gains and thus lower taxes.

If the sale was solely to realize a capital loss for taxation purposes, the investor will want to re-establish the position after the 30-day period required to avoid the superficial-loss rule. The investor might take a chance that the price will be the same, lower or might choose to hold a proxy for the fund's price movement.

Tax-loss selling tends to occur during August to late December. That's also the period when many funds have estimated the capital gains and income they will be distributing to investors, at year end. These amounts are taxable in the hands of the investor, so an additional reason to sell a losing fund from, the tax point of view, may be to avoid a large year-end distribution that would require paying additional taxes. (Read Capital Gains Tax 101 , for more insight.)

The Bottom Line
Although these eight reasons should compel you to consider getting rid of your fund, remember to keep the impact of deferred sales charges, short-term trading fees and taxes in mind whenever you sell. If these other factors don't fall in your favor, it may not be the best time to get out.

Related Articles
  1. Mutual Funds & ETFs

    Mutual Funds Are Not FDIC Insured: Here Is Why

    Find out why mutual funds are not insured by the FDIC, including why the FDIC was created and how to minimize your risk with educated mutual fund investments.
  2. Professionals

    How to Sell Mutual Funds to Your Clients

    Learn about the various talking points you should cover when discussing mutual funds with clients and how explaining their benefits can help you close the sale.
  3. Taxes

    The 5 Countries Without Income Taxes

    Discover information on some of the best countries to consider relocating to that offer the financial benefit of charging no income tax.
  4. Mutual Funds & ETFs

    Top Three Transportation ETFs

    These three transportation funds attract the majority of sector volume.
  5. Professionals

    Tax Efficient Strategies for Mutual Funds

    Before you sell mutual fund shares, consider these tax strategies first.
  6. Professionals

    Fund and ETF Strategies for Volatile Markets

    Looking for short-term fixes in reaction to market volatility? Here are a few strategies — and their downsides.
  7. Investing Basics

    Statistical Proof That Buy-and-Hold Investing Pays Off

    Learn about how the data suggests that the buy-and-hold investment strategy still works, even after the huge declines of the Great Recession.
  8. Investing

    How Diversifying Can Help You Manage Market Mayhem

    The recent market volatility, while not unexpected, has certainly been hard for any investor to digest.
  9. Investing

    How to Win More by Losing Less in Today’s Markets

    The further you fall, the harder it is to climb back up. It’s a universal truth that is painfully apparent in the investing world.
  10. Investing Basics

    5 Things To Ask Before Hiring A Financial Advisor

    Choosing a financial advisor isn't an easy task. Here's a list of the most important things to consider when planning for your financial future.
  1. Why is the Cayman Islands considered a tax haven?

    The Cayman Islands is one of the most well-known tax havens in the world. Unlike most countries, the Cayman Islands does ... Read Full Answer >>
  2. Can mutual funds invest in hedge funds?

    Mutual funds are legally allowed to invest in hedge funds. However, hedge funds and mutual funds have striking differences ... Read Full Answer >>
  3. Why is Luxembourg considered a tax haven?

    Luxembourg has been the tax haven of choice for many corporations and mega-rich individuals around the world since the 197 ... Read Full Answer >>
  4. What are the main kinds of annuities?

    There are two broad categories of annuity: fixed and variable. These categories refer to the manner in which the investment ... Read Full Answer >>
  5. What are the risks of rolling my 401(k) into an annuity?

    Though the appeal of having guaranteed income after retirement is undeniable, there are actually a number of risks to consider ... Read Full Answer >>
  6. Why is Panama considered a tax haven?

    The Republic of Panama is considered one of the most well-established pure tax havens in the Caribbean due to extensive legislation ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
  2. Revenue

    The amount of money that a company actually receives during a specific period, including discounts and deductions for returned ...
  3. Normal Profit

    An economic condition occurring when the difference between a firm’s total revenue and total cost is equal to zero.
  4. Operating Cost

    Expenses associated with the maintenance and administration of a business on a day-to-day basis.
  5. Cost Of Funds

    The interest rate paid by financial institutions for the funds that they deploy in their business. The cost of funds is one ...
  6. Cost Accounting

    A type of accounting process that aims to capture a company's costs of production by assessing the input costs of each step ...
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!