Sell the Laggards? Maybe, Maybe Not

It's OK to admit it: The stock market's been on a tear, but your money's been in a "clunker" fund that doesn't seem to know a stock from a stink bomb.

Thanks to good times on Wall Street, these clunkers can seem rather rare these days, but it's not unusual to face a tough decision: whether to sell a laggard fund or give it just one more year.

The key, analysts say, is a systematic look at your portfolio. That means not selling a fund out of anger over a bad quarter, or holding one because of emotional attachment, despite persistent underperformance.

Selling is often easier said than done, says mutual-fund expert Sheldon Jacobs, who publishes the No-Load Fund Investor, a newsletter in Irvington-on-Hudson, N.Y. People get attached to their holdings or just don't know when to pull the trigger on a poorly managed fund.

But the decision to sell can be almost as important as the decision to buy. That's because, over time, small differences in your rate of return can turn into big differences in the value of your account.

Fund experts say it's time to sell a fund when:

* It repeatedly lags behind its peers.

* Its manager has left, and the new manager can't seem to duplicate his predecessor's success.

* It has switched to an investment style that no longer makes sense for you. Example: when a "mid-cap" fund, investing in mid-size companies, becomes a large-cap fund, and you already own a large-cap fund.

* It is in a sector that has dropped out of favor for a substantial period of time. Example: gold funds.

* It has posted a large loss, and the loss can be used to offset taxes on a gain elsewhere. If the fund plays an important role in your overall plan, such as giving you exposure to foreign stocks, you can then buy a more promising fund with the same objective.

In a taxable account, you should consider whether the advantages of switching outweigh the tax consequences of selling.

In tax-sheltered 401(k) plans or individual retirement accounts, you don't have to pay capital-gains taxes when you sell funds. You are much freer to move your money around.

Selling, in a sheltered account, depends on fund performance and investment goals, says Russel Kinnel, head of equity analysis at Morningstar Inc. in Chicago.

Guard against a rear-view-mirror approach. A few bad quarters don't necessarily mean a fund is a dog for the long haul. Funds, for example, that invest in small companies often trail broader market performance, then rush to catch up.

And don't blame a fund unfairly. Compare its performance to peers with the same objective (see the fund categories chart on Page B8), not just to market averages. If you want to match the Standard & Poor's 500 index of large companies, buy an S&P 500 index fund.

Studies repeatedly confirm that buy-and-hold investors tend to outperform frequent sellers, or market timers who pull in and out of stocks. One reason: Top-performing funds tend to be fairly consistent, despite the occasional bad quarter. So while selling has its day, remember that holding is also important.

When in doubt, experts say, hold. When soured by a fund, sell.