Establish Criteria to Buy and Sell Your Funds

Physician's Money Digest, April 2006, Volume 13, Issue 4

Suppose you own Clipper(CFIMX) or Ariel (ARGFX).Should you sell either fundnow? Both of these fundsunderperformed comparedwith corresponding index funds andcategory averages in 2005. You maysay, "I am not going to bail out of afund just because it did not do well for1 year."Good for you. But if you lookback, one of these funds has performedpoorly on a relative basis for the pastseveral years. How long should youwait before pulling the plug on a fund?

Buy-and-sell Criteria

Most investors never develop andadhere to a set of criteria for selling afund. They make a gut-feeling judgmentbased on a fund's performanceover a few years. If a fund performspoorly (on an absolute or relativebasis) for 2 or 3 years in a row, theysell the fund. Other investors neverlook at the performance of their funds,especially on a relative basis. Theyoften hold on to horrible funds foryears and waste thousands of dollars.

Clearly, if you want to invest successfullyin mutual funds, you musthave well-thought-out criteria for sellingit. But establishing criteria for sellingreally begins with setting criteria forbuying. If you follow a set of specificbuying standards, then you will buyonly when funds meet those criteria,and sell only when they no longer meetyour important criteria—regardless ofhow well the fund is doing.

Review During Change

Let me illustrate using the funds Icited. If you owned the Clipper fundin 2005 or earlier, your key reason forbuying it would have been that youagreed with the value investment philosophyof long-time manager JamesGipson. You also agreed with his policyof holding a substantial amount ofcash when he thought the market wasovervalued and could not find stocksthat met his value measures.

Clipper significantly underperformedbenchmarks in 2003, 2004,and 2005 primarily because Gipsonheld substantial cash. Clipper also significantlyunderperformed the marketin the late 1990s for the same reason.Gipson believed that the market wasin a bubble at that time, and he didnot want to participate in it if heturned out to be right. Clipper significantlyoutperformed the market whenmeasured over a longer term, includingthe bubble years.

Gipson and his team left Clipper atthe end of 2005 in part because of thefund's poor performance. But shouldyou hold on to Clipper now? The newmanagement team at Clipper has anexcellent reputation as value managers.This team is not likely to use itsjudgment about the market's valuationlevel to significantly vary thefund's cash holding. Clipper is now adifferent animal, and you have todecide if the new Clipper still fits intoyour portfolio.

In the case of Ariel, if you bought itfor the expertise and great long-termrecord of John Rogers as a value manager,neither has changed. But if youalso bought Ariel to fill your portfolio'ssmall cap value allocation, youmay want to sell it. Ariel's asset basehas grown significantly, and it is nowa mid cap blend fund.

All of this brings up another keyissue. Actively managed funds are likelyto experience manager turnover, stylechanges, and performance deviationsfrom benchmarks from time to time. Soif you are holding equity funds in taxableaccounts, you should anticipatethe tax consequences of such changesand may want to put more of yourindex funds in taxable accounts.

Chandan Sengupta, author of The Only

Proven Road to Investment Success (John

Wiley; 2001) and Financial Modeling Using

Excel and VBA (John Wiley; 2004), currently

teaches finance at the Fordham University

Graduate School of Business and consults with individuals

on financial planning and investment management. He welcomes

questions or comments at