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When
Your Mutual Fund Plummets in Value
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Dear Dollar Diva,
I received a $7,000
inheritance when my grandmother died last year and
invested it in a no-load, aggressive-growth mutual
fund. It is now worth barely $3,000. When I first
bought the fund, Morningstar gave it a 5-star rating;
a couple of months later, it was down to 3-stars.
Should I sell this dog? I am 27 years old and single;
my investment goal is long-term growth.
Nina
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Dear
Nina, |
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| Congratulations on selecting
a no-load fund. At least you don't have to agonize over
losing a 5 or 6 percent load if you decide to sell. |
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| Your fund is down a whopping
57 percent -- ouch. Most equity mutual fund investors
are suffering post-traumatic stress over their recent
losses; a glance at the Russell U.S. equity index returns
shows that the market took a beating over the past year.
The Diva will address your fund's hefty loss after she
answers your question. |
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| Should you sell? |
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| Selling is a way to make
lemonade out of this lemon. Since your mutual fund is
not in an IRA or other tax-deferred retirement plan, you
can sell all or part of your investment and take the capital
loss deduction. Then, immediately reinvest the proceeds
in another mutual fund, to keep the money working for
you. |
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| But be careful: If you
fall back in love with this particular fund you need to
know about the IRS "wash sale" rule before you buy it
back again: If you buy a "substantially identical stock" within 30 days before or after the sale of stock that
you previously owned, you cannot take the loss deduction. |
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| Substitute "mutual fund"
for "stock," and it means, if you want to take the loss,
you have to wait 30 days after you sell before you can
buy the same mutual fund back again. However, there's
no law that says you can't purchase a different aggressive-growth
fund or any other kind of investment that makes sense
to you. |
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| Reminder: If you don't
have capital gains to offset the capital loss, the maximum
capital loss deduction allowed in any one year is $3,000.
But don't worry: if your loss is greater than $3,000,
you won't lose it. You can carry it over to future years
to offset capital gains and/or deduct the maximum $3,000
capital loss each year until it's used up. |
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| Morningstar's ratings
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| It sounds
like you're familiar with Morningstar and its "star rating" system. Morningstar provides independent, mutual fund
and stock analysis, but its mutual fund ratings are on
past performance only. It's too bad you had to learn the
hard way that past performance is no guarantee of future
results. |
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| The Morningstar "star
rating" is not the best tool for measuring your fund's
performance against other funds in its category. The "star
rating" system would have compared the performance of
your mutual fund against the performance of the whole
domestic-equity universe, even though your aggressive
growth fund might only invest in small or mid-cap growth
stocks. The "star rating" system often ends up comparing
apples with oranges and is not the best research tool
for measuring most mutual funds. |
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| The better rating is
the "category rating." It's on the same front page of
the Morningstar Quicktake Report as the "star rating," so it's easy to find. Your fund's risk and return will
be compared with funds in the same category (i.e. large-cap,
mid-cap or small-cap; growth, value or blend); apples
will be compared with apples; oranges with oranges. |
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| If you sell, what should
you buy? |
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| Your fund's 57 percent
loss is pretty awesome, but not unheard of; the 21st century
found many aggressive-growth funds drowning in the high
tech blood bath. One high-tech player, Lucent Technologies,
lost almost 80 percent of its value over the past 12 months,
and it has plenty of company. |
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| But history tells us
that categories of stock regularly jump from the bottom
of the heap to the top. Sometimes it happens in a year,
sometimes it takes a couple of years, and sometimes a
category slides around in-the middle before it moves up
or down. The one sure thing is: No category stays on the
top or bottom forever. |
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| The Diva is not a mutual
fund analyst and she doesn't know what fund you own, or
if it's any good. She's going to link you to Morningstar's "When to sell a fund" to help you make a decision on your
fund, and on whether you should stay with aggressive growth
or move your assets into something less volatile. The
six areas it touches on are: |
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1.
The fund loses more than it should. 2. The fund gains
more than it should. 3. The fund changes strategy. 4.
The fund underperforms for a long period. 5. Your goals
change. 6. You just can't take it any more. |
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| You have to remember
that investing in aggressive-growth stocks is a long-term
bet. At 27, you have the time to weather the ups and downs
of this type of investing. But do you have the stomach
for it? |
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| Index funds |
| If you don't have the
time or inclination to research a fund and read its prospectus
before you buy, you should go with a no-load, low fee
index fund that follows the market you are interested
in. Vanguard is the big daddy of index fund investing,
but many other financial institutions offer them too.
Use your favorite search engine to help you sniff them
out. |
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| -- Posted: Dec. 10, 2001 |
| DOROTHY ROSEN has a master's
degree in finance, with a specialization in accounting,
from the Kellogg Graduate School at Northwestern University
in Evanston, Ill. Rosen has more than 15 years of experience
in the financial arena, serving in Illinois and Florida
as a certified public accountant, financial consultant,
expert witness and educator. She is owner of Dorothy Rosen,
CPA, a public accounting firm that serves individuals
and small businesses. |
