Should you sell your mutual fund when it generates a loss? Not necessarily, here’s why
Losses are not always a bad sign for mutual funds, unless it lasts for a prolonged period
Dubai: If you have noticed that your mutual fund consistently generates poor performance over the last two or more years, it may be time to cut your losses and move on. But should you do that if the fund occasionally gives you negative returns or generates a loss? No, here’s why that is.
“While investments in mutual funds are beneficial for building wealth over the long term, they are also subject to a variety of risks – one of them being the fund’s returns recurrently going into negative or turn a loss,” said Brody Dunn, investment manager at a UAE-based asset advisory firm.
“When investing in mutual funds, deciding to sell your investment based purely on profit and loss could backfire. A better way is to follow a set of rules. You should stay invested for a longer term, unless there is something wrong with the fund or you desperately need liquidity.”
When investing in mutual funds, deciding to sell your investment based purely on profit and loss could backfire
When does a mutual fund perform poorly?
There are two instances a mutual fund can perform poorly, experts explain. It could be due to a poor market or the fund manager's poor fund management skills. If your mutual fund is performing poorly because stocks markets have been consistently down, investors should continue to invest.
However, if poor fund management is dragging down performance, investors are advised to immediately exit the fund and reinvest in a fund with a proven track record of performance, which is information you can easily find out from the investment broker you are opting to use.
With mutual funds, you should be ready to witness ups and downs in the short term. However, your fund's volatility will depend on its category and market conditions. For instance, a mid-cap fund will be much more volatile than a large-cap fund. So, ensure your fund is ‘underperforming’. Here’s how.
How to know a mutual fund is underperforming?
“Underperformance is when the fund gives less returns than other funds of the same type,” said Zubair Shakeel, an investment advisor working with another UAE-based asset manager. “What you should do is check its performance compared to other funds of the same category.”
“It is generally recommended to exit a poorly performing mutual fund if it has consistently underperformed its benchmark over a sustained period of time, typically 1-2 years. Investors should also consider why the fund is performing poorly and evaluate if the issues are likely to persist.”
It is also interesting to note that multiple global surveys indicate majority investors ending up exiting a fund based on short term outperformance (9-12 months) only to discover that the fund that they redeemed didn’t just recover, but outperformed the pack over the next few quarters.
What other mistakes are made with mutual funds?
“Mutual fund investors also often end up exiting outperformers because their frame of reference is incorrect. For example, small caps may have underperformed in a particular year compared to large caps. However, your small cap fund may have fallen the least compared to its peers,” Shakeel added.
“So, exercise caution while evaluating your fund’s performance by choosing the correct frame of reference. If your goals are long term, you should continue your fund because the turnarounds can result in capital growth in a short period of time, and you don’t want to be missing out.”
Once you have invested in a specific mutual fund scheme, you will be widely recommended that you allow sufficient time, which is about 8-10 years for long-term financial goals, for your investments to reap their rewards, while also tracking them every three to six months.
Key takeaways
Every type of market investment carries some kind of risk. Changes large and small, whether in the specifics of your portfolio or the overall state of the global economy, drive market fluctuations which can affect your investments.
While mutual funds have many advantages – from the power of pooled investment resources to professional portfolio management – they are subject to the same market and economic forces that all investments face.
A good rule of thumb that most investors live by is to cut losses anytime an investment falls 5-8 per cent below the price you purchased it at
Or course, risk is part of any investor’s portfolio. Even if you didn’t invest at all, you’re facing an opportunity risk, which is the risk that you could have grown your wealth more by participating in the markets than sitting on the side lines.
“A good rule of thumb that most investors live by is to cut losses anytime an investment falls 5-8 per cent below the price you purchased it at. It’s true that the earlier you accept a loss, the more money you'll save in the long run, but small losses are not necessarily bad with mutual funds,” added Dunn.
“However, if you have noticed significantly poor performance over the last two or more years, it may be time to cut your losses and move on. To help your decision, compare the fund's performance to or to similar funds. Exceptionally poor comparative performance should be a signal to sell the fund.”