When to buy, sell or hold

Buy and hold. That's the advice investment professionals offer long-term

investors. And it makes a lot of sense if your investments continue to perform

as expected. But what if they don't?

Stocks (and mutual funds that own stocks) fluctuate in value when a

particular market sector, say drug companies or retailers, temporarily falls

out of favor with investors. Investors move their money into high-flying

sectors, and the prices decline for the out-of-favor stocks that are no

longer in demand.

Don't confuse price fluctuation with under-performance. No mutual fund

appreciates without pausing. Selling your mutual fund shares when its price

drops is a mistake.

For long-term investors, the normal "rotation" from one sector to another

should count for very little. As long as nothing alters the fundamental

outlook for your investment, don't sell because of temporary shifts in demand.

Having said that, there is no excuse for falling asleep at the wheel.

Many factors may alter a mutual fund's fundamental attractiveness. What

may have looked like a great investment five years ago may now appear unattractive.

Economic conditions change. Mutual fund managers change. Competitive forces

can alter the fundamental outlook for a company or industry. Because of

the dynamics of our economy, mutual fund managers must constantly evaluate

the performance of every company in their portfolio and be prepared to act

swiftly and decisively if a company's profit outlook changes.

But what if the manager drops the ball?

If you want satisfactory investment results, you must periodically evaluate

the performance of your portfolio to ensure that your investments are performing

as planned. At times, a decline in the value of a mutual fund's shares may

portend further declines.

Here are some warning signs you should look for:

* A mutual fund underperforms its peers for one to two years. If that

happens, call the investor relations department and ask why. If you don't

get a satisfactory answer, the fund may be a candidate for sale.

* Your asset allocation formula has become unbalanced. If you have decided

upon a particular mix for your investment portfolio, say 60 percent in equities,

30 percent in bonds and 10 percent in cash, you should periodically check

and adjust the asset allocation within your portfolio. If the equity portion

has appreciated and now represents 70 percent of your portfolio, liquidate

some of your equity holdings and reallocate the proceeds.

* Your personal needs change. A major event in your life, e.g., a child's

wedding or the need to finance a college education, may require you to raise

cash by selling some portion of your portfolio.

* There are excessive mutual fund expenses. If your mutual fund incurs

excessive expenses, for example, more than 1.5 percent, and the fund is

not outperforming its peers, look for a comparable fund with lower expenses

and better performance.

* There is a large increase in a mutual fund's assets. The smaller a

fund is, the easier it is for the manager to move nimbly. As a fund grows

in size, the manager's job becomes harder. Case in point: Fidelity Magellan.

This fund has become so large that it is virtually impossible for the fund

manager to outperform the market because the fund is the market.

* A "small-company" fund (funds that invest only in companies whose

market capitalization is less than $1 billion) gets too big. Once a small-company

fund has more than $500 million in assets, look for a similar fund with

fewer assets.

* You have tax considerations. Losses or gains in your other investments

may necessitate offsetting losses/gains to minimize taxes. But before acting,

talk to your tax adviser.

* Your portfolio is too large. For most investors, owning five or six

mutual funds is more than enough diversification. Prune the size of your

portfolio if it exceeds this amount.

Zall, Bureaucratus columnist and a retired federal employee, is a

freelance writer based in Silver Spring, Md. He specializes in taxes, investing,

business and government workplace issues. He is a certified internal auditor

and a registered investment adviser.


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