Time To Part Ways With Your Favorite Fund - Adios Amigo

All good things must come to an end. Mutual funds can also lose their magic. We'd love to say that a good fund will always be good, but funds change. Performance slips. Managers leave. Strategies evolve. That's why funds need to be monitored. Here are some of the warning signs to watch out for. These aren't sell signals per se: 

Asset Growth

This may seem counterintuitive, but sometimes mutual funds actually need smaller audiences. As funds attract new investors and grow larger, their returns often become sluggish, weighed down by too many assets. They lose their potency and their returns revert to the average for their group. Some funds stop accepting money from new investors when their assets grow too large, but many don't. That explains why so many once-hot funds become mediocre. As hot shot funds grow, their returns may become sluggish, weighed down by too many assets. They lose their potency and become average. It happened to Fidelity Magellan FMAGX, which is no longer the total-return powerhouse it was when it had less than a billion dollars under its belt. This might even happen to FSCRX.

Asset size can impede performance for any fund, but some types of funds are hurt more than others. It depends on a fund's style.. Generally very large funds may have difficulty buying very small stocks. It's tough to put large dollar amounts to work in a small market. Small-cap stocks take up less than 10% of the U.S. market's overall assets; large caps, meanwhile, account for about two thirds of the market. It's therefore easier for a fund manager with a lot of assets to buy bigger companies than to own a small fry. Asset overload is especially detrimental to small-cap funds that trade a lot. Sometimes mutual fund shops will do the monitoring for you. No matter what they do, though, they have to make concessions or close the fund. More often than not, fund managers cope with huge asset bases by altering their strategies. Some will buy more stocks. And as a shareholder, you need to be aware of the change and consider whether or not this altered fund fits into your portfolio.

Manager Changes

Most mutual funds are only as good as the people behind them: the fund managers. Managers decide what to buy, what to sell, and when to make these changes. Because the fund manager is the person who is most responsible for a fund's performance, many investors wonder if they should sell a fund when their manager leaves.

Unfortunately, there is no one right answer to this question. You'll need to consider a few factors. For example, you may have to pay taxes on your sold shares, if they've appreciated since you bought them. And what you give up in taxes may not be offset by future gains in a different fund. You'll also need to consider the record of the new manager—perhaps he or she has already worked on the fund? Perhaps the manager has racked up a solid record at another offering? Keep in mind: A new manager may do just as well as the old.

Further, management turnover won't make much difference when it comes to certain kinds of investing styles.

The Fund Loses More than It Should

Suppose a bond fund loses more than 23% in a year in which its average peer suffers a much slimmer loss. Shareholders who expected boring bond performance should have sold.

The Fund Underperforms for a Long Period

While one year of underperformance may be nothing to worry about, two or three ugly years can get frustrating. The urge to sell intensifies. Before pulling the trigger, be sure you're comparing your underperformer to an appropriate benchmark.

The Fund Changes Its Strategy

Presumably, you buy a small-value fund because you want exposure to small-value stocks. If the manager suddenly starts buying large-growth stocks, you may have a problem. After all, you may already have a large-growth fund in your portfolio.

Your Goals Change

You don't invest to win some imaginary race, but to meet your financial goals. As your goals change, your funds should change as well. Suppose you start investing in a balanced fund with the goal of buying a house within the next five years. If you get married and your spouse already owns a house, you may decide to use that money for retirement instead. In that case, you might ditch the balanced fund for a pure stock fund.

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