When Should You Sell Your Mutual Fund?

September 18, 2014

As the stock market reaches new highs, have you been wondering if you should sell and take profits before the next eventual dip? If the stock market does take a dip, should you sell and cut your losses? With the launch of our “Ask a Planner Week” on Monday, here was the first question we received: “I have absolute percentage rules for taking profits and losses on individual stocks. When should one consider taking profits or losses on index funds?”

First, understand that there’s a big difference between individual stocks and the market as a whole, which is what an index fund is generally designed to track. An individual stock can go to zero (remember Enron, anyone?) so it may make sense to limit your losses. Fortunately, you can easily do that by setting a stop-loss order that will automatically sell the stock if it falls below a certain price. Of course, the downside is that you can miss a rebound in the stock price.

However, the stock market as a whole practically can’t go to zero. Think about it. That would mean every major company in the country (or even the world if you use a global index fund) would be completely worthless. It would take something akin to the Zombie Apocalypse for that to happen.

Not only that, but it’s almost impossible for the stock market not to eventually recover after a downturn. That would mean no more economic growth, in which case we’re probably just a few short steps from that Zombie Apocalypse. So instead of selling and cutting your losses, it might actually make sense to add MORE money to your fund by rebalancing.

For example, if your target investment allocation based on your time frame and risk tolerance is 60% stocks and 40% bonds and your portfolio is now 70% stocks and 30% bonds after a particularly strong year in the stock market, you may want to sell enough stocks and buy enough bonds to bring you back to that 60/40 ratio. Otherwise, you’re taking on more risk than you should, although it may not feel that way at the time. This also gives you an opportunity to take some of your profits off the table.

Vice versa, when the market eventually takes a downturn and you have 50% in stocks and 50% in bonds, you would sell enough bonds and buy enough stocks to bring you back to 60/40 again. By doing this consistently at least once a year, you would be buying stocks relatively low and selling them relatively high without trying to time the market. Your retirement plan provider may even offer an automatic rebalancing feature that does this for you (one stop shop asset allocation funds like target date funds also rebalance themselves for you).

There is one final point about taxes. If you have investments in a taxable account, you might want to sell losses so you can use them to offset other taxes. Just be sure to reinvest the proceeds in a different fund (if you buy a “substantially identical” investment within 30 days, you can’t take the loss off your taxes) so you don’t miss a recovery.

In summary, don’t plan to buy or sell a fund based on a certain percentage gain or loss. Instead, buy or sell as needed to rebalance your portfolio at least once a year and consider selling losses in taxable accounts and reinvesting the proceeds. It may feel scary to trust your money with something as impersonal as “the market” but you’ll be okay…as long as there’s no Zombie Apocalypse.