As much as you might like to sell in May and go away, what you need to do right now is review your portfolio top to bottom.
The sell-in-May adage harks back to an era of Wall Street money managers who, we're told, wanted to enjoy some peace and quiet in the Hamptons without worrying about missing a summer rally. You too might rather relax at the beach rather than evaluate your monthly fund statements. But every investor should periodically review everything from expenses to performance -- and if something doesn't match, pack the manager's bags.
Provided your mutual fund manager keeps his nose clean and his expense ratio within reason, perhaps the most significant issue is making sure the manager stays with the philosophy you thought you were buying into when you purchased shares of the fund.
In other words, make sure you get the management you are paying for by following these simple practices:
Read the prospectus. The prospectus serves as the fund's promise to take care of your money according to your requirements. Managers that fail to adhere to their stated philosophy endanger investors' diversification efforts.
Review holdings twice a year. If you find a growth stock in your value fund, you need to find out why and take action if necessary. It's similar to finding a fly in your soup in a restaurant. What do you do? You send it back to the kitchen!
Set a standard for service. If you find yourself wasting too much time on hold waiting for an answer to a simple question about your fund, then you might want to shop around for a replacement.
Get a second opinion. With all of the financial resources currently available online at Morningstar.com, Lipper.com and elsewhere, investors can easily and quickly compare notes to see if they are in a fund that's right for them.
That's the short version of reviewing your funds. But don't forget to consider these other issues as well.
Whose Side Are They On?
The mutual fund scandal was still on the minds of attendees at the annual Investment Company Institute meeting held earlier this month, but it was a far less heated topic. Last year, the fund industry's main trade group was still in crisis control mode, answering calls from investors still smarting from the revelations that unsavory characters were late trading and market-timing their funds with impunity.
Fast forward to this year, when perhaps the best attended seminar was on how to market funds to baby boomers who are living longer.
Similarly, the pace of withdrawals from scandal-tainted fund companies like
has tailed off since the crisis came to a head. On the whole, these companies have retained the majority of their business by promising to clean up their act and offering retribution to deceived investors.
But just because the fund families have done an admirable job of putting this ugly episode behind them does not mean investors should forget what to do if a similar scandal arises in one of their funds.
Max Rottersman, founder of FundExpenses.com, advocates quick punishment. He says investors should fire fund managers upon the first sign of scandal.
"If you heard that your plumber was stealing from you, then you would fire him as well and never let him back in your house. Why should your mutual fund company be different?" asks Rottersman.
If you're more forgiving, though, you can track your funds' stewardship grades on Morningstar.com. On this site, fund tracker Morningstar rates funds using measurements like board quality and response to regulatory issues.
Contrary to popular belief, success in the stock market is not always about making more money than your know-it-all neighbor. In fact, the best way to keep up with the Joneses is by sticking to a solid investment plan that delivers steady performance.
Roy Weitz, CPA and founder of FundAlarm.com, says the choice of a reliable, quantifiable benchmark is the first step toward accurately assessing a mutual fund's performance. Weitz says that the
index or the
Vanguard 500 Index mutual fund are good benchmarks for evaluating the performance of a fund that invests in large-cap U.S. stocks. But when it comes to special classes of funds, Weitz admits it's not easy to arrive at the perfect benchmark.
"If you classify mutual funds by objective, you would probably want benchmarks that mirror those objectives," says Weitz. "Similarly, if you classify mutual funds by the capitalization of stocks that they own, like large-cap or small-cap, you would probably want benchmarks classified by capitalization."
Instead of searching for the perfect benchmark, Weitz uses the six funds as yardsticks to measure an individual fund's performance. If a fund consistently underperforms its benchmark, investors should consider selling it. Here are his six yardsticks:
Balanced: (VBINX) Vanguard Balanced Index.
International: (SWINX) Schwab International Index.
Domestic large-cap: Vanguard 500 Index.
Domestic mid-cap: Dreyfus (PESPX) MidCap Index.
Domestic small-cap: (NAESX) Vanguard Small Cap Index.
Specialty: FundAlarm's Specialty Benchmarks.
The FundAlarm benchmarks were designed to evaluate the performance in eight specialty-fund categories: communications, financial, health, precious metals, natural resources, real estate, technology and utilities.
Time Is of the Essence
Picking the correct benchmark is the first step in evaluating a mutual fund, but time is also a significant factor in the decision. Chasing performance can cost just as much as sticking with a loser too long. As a general rule, investors should avoid performance comparisons over very short or very long periods.
FundAlarm.com's Weitz recommends examining fund performance over multiple, intermediate periods of one, three and five years to get more depth and perspective.
Kunal Kapoor, Morningstar's director of fund analysis, proposes a five-year benchmark because the market moves in cycles. However, he says that "if something significant happens to the fund, like a manager departing, then that might call for a re-evaluation."
By itself, manager turnover is not a reason to sell a mutual fund. But as Weitz describes in his FundAlarm.com article "Deciding to Sell a Mutual Fund," information about manager turnover can help you interpret fund performance data.
"In some cases, a change in fund management can explain a pattern of deteriorating performance, and reinforce a tentative decision to sell that was based on performance information. In other cases, a recent change in fund management may encourage you to hold onto a fund that has performed poorly."
Fees Can Be Another Problem
Poor investment performance should not be the only impetus to switch mutual funds. Fees need to be considered as well. High fees unnecessarily curb total return, turning moderate outperformance into a mediocre investment, while paying above-average fees for subpar returns adds insult to financial injury.
Nobody should overpay for financial services when it's not necessary. But how do you know when you are getting ripped off?
A good first step is to determine industry norms. Morningstar says the average domestic mutual fund expense ratio is 1.52% and the average international equity fund expense ratio is 1.86%. In fixed income, Morningstar places municipal bond fees at 1.01% and taxable bond fees at 1.13%.
But even if you beat these benchmarks, don't splurge your savings just yet. Some experts feel the average cost for managing a fund is still too high.
"If you are paying more than 1% to have your assets managed, you are paying too much," says Rottersman of FundExpenses.com.
To watch Gregg's video on how to perform a checkup for your funds, click here.