by Gary Foreman
Dear Dollar Stretcher,
My mutual funds have continued to go down. I've only had this account for one month. As a new investor should I "panic sell?" When would be the time to withdraw? Can you write an article about the current standings on the mutual funds market? What should we investors do? Wait for how long? Or cut our losses and go for much less volatile investments like T-Bills and CD's?
M.A. asks a good question. And based on the large number of new investors that are entering the investment arena today, I suspect he's not alone. How do you decide whether it's time to sell? While M.A. doesn't give us enough information to make the decision for him, we can explore some of the reasons that you'd want to sell an investment. Then M.A. can look at the circumstances and decide for himself.
One reason to sell a stock or fund is mentioned in the question. That's the 'panic sale'. As a general rule you should never make any investment decision while in a 'panic' situation. The truth is that people don't make good decisions when they're under that type of stress. Mistakes are often the result.
But, there's another side to that coin. If you have an investment that has the ability to make you panic it's probably a poor choice for you. If it can cause you to lose sleep, it's wrong. It could be that you don't understand how the investment works. Or you've put in too much of your money. Or maybe you just don't have the temperament to take that type of risk. Any one of those is enough of a reason to sell and put the money into something that's within your comfort zone.
M.A. points to another possible reason to sell. That's because you're losing money. If your goal is to make some fast money in the market you need to get rid of losers quickly. Professional traders often decide how big a loss they're willing to risk before they even buy a stock. For instance, before buying a $10 stock they'll decide to sell if it drops to $9. Period. No questions asked. There are two reasons for this. First, if a stock starts to drop you have to wonder why. Is it something that you didn't know when you bought it? It's possible that you've overlooked something. And you don't want to lose too much money finding out what it is.
Second, losers can be really hard to overcome. Consider our $10 purchase. Suppose it drops 25% to $7.50 and we sell it. Now we now have only $7.50 to invest. We'd need a $2.50 increase (33%) to get back to our original $10. And that's not including commissions. Because of that most pros will sell a stock if it loses just 5 or 10%.
But M.A. needs to consider why he purchased the fund. Suppose he was saving for retirement and had 20 years to go. Then a 10% loss might not be a reason to sell the fund. If the fund went down due to general stock market conditions then he'll probably want to ride out the bumps.
For most long-term fund owners the best strategy is to buy and hold. The reason is simple. If you had invested in the stock market and left your money alone for 10 years it would have increased in value. And not just the last 10 'bull market' years. You could have invested the day before the 1929 crash and you still would have been ahead 10 years later. Time has the effect of reducing the risk of an investment.
There are probably some of you that are wondering why we don't sell at the top and rebuy the fund after it's dropped. M.A. hinted at that in his question. The strategy is called 'market timing'. The reason we don't recommend it is simple. We can't see into the future. Unless you're really sophisticated, really talented and really good, you'll miss many of the highs and lows. And that will eliminate any advantage you might have gained. Some people try to use a variation on marketing timing. If they think that the market is about to take a dive they'll sell a portion of their fund shares, perhaps 25% or 50%. That way no matter which way the price goes they'll be right with part of their money. This works much better than being completely invested or uninvested.
Finally, M.A. asked about moving into something less volatile. The time to address that is before you choose your investment. You need to decide what you want that investment to accomplish before you put money into a mutual fund, T-Bill, CD or any other investment. If you'll need the money soon or you can't afford losses, then choose T-Bills, CD's or money market funds. You'll earn less but your money will be safer.
On the other hand, if you're accumulating money for retirement then a mutual fund investing in stocks would make a better choice. Sure, you'll have a little more volatility and will probably even lose money some years. But your average return over the long haul will be higher.
One final note. It's probably a good time for M.A. to step back, take a deep breath and consider what he's trying to accomplish with his investments. A sound investment plan is an important part of your financial future. But jumping at a stock or mutual fund because it looks like easy money generally doesn't work out.
Take a little time to consider your goals. Evaluate your ability to take risks. Know how many years you have for your plan to take effect. We hope M.A. has made a good choice and that his mutual fund has already started to turn around.
Gary Foreman is a former financial planner and purchasing manager who founded The Dollar Stretcher.com website and newsletters in 1996. He's been featured in MSN Money, Yahoo Finance, Fox Business, The Nightly Business Report, US News Money, Credit.com and CreditCards.com. Gary shares his philosophy of money here. You can follow Gary on Twitter. Gary is also available for audio, video or print interviews. For more info see his media page.