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Four Questions to Ask Before You Switch Funds

November 2006

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Wall Street firms often make it easy to move money from one fund to another. In fact, dubious innovations such as the Fidelity Select line of industry-focused funds were explicitly designed to encourage investors to trade mutual funds. But active fund trading generally adds to hidden costs and market timing errors, detracting from performance rather than adding to it. Just as you look for low turnover in a fund, you should also aim to keep the core of your family portfolio as stable as possible. Sometimes it can make sense to sell a fund, particularly one that’s very high cost, but ask yourself these four questions first:

Do I expect the new fund to do as well or better over the next 10 years, or am I just chasing this year’s hot trend?
Even the very best managers will go through two- to five-year slumps. Entire investment categories can go out of favor for decades. This does not mean that they are serving no useful purpose in your portfolio. Too often, investors get discouraged and throw in the towel just as the category takes off again or the manager gets hot and thus sacrifice the benefits of diversification that they were seeking when they first bought the fund.

Does the switch change the overall balance of my family’s portfolio and does this make sense?
Aim for a balanced portfolio with core holdings that cover all the basic asset classes and subclasses. In general, when you make changes (for example, increasing your exposure to international stocks) make the changes gradually over several years.

How much will it cost me (in capital gains taxes, redemption fees, commissions) to sell my old fund and buy the new one?
Not all switching comes free of charge. If you hold Class B shares or if you cash in an annuity too soon, you’ll typically be charged a hefty exit fee. If your fund is in a taxable account, you may get hit with a big capital gains bill that will negate any benefit you might have gotten from switching funds.

How much money will I save if I switch funds, and how quickly will I earn back the costs of switching?
Saving money is generally the best reason to switch funds. But make sure that the cost savings are enough to offset any commissions or taxes. Also be sure that the cost savings are likely to be lasting. Funds will sometimes offer “fee waivers”, resulting in lower expense ratios for a few quarters or a year. The best practice is to use the expense ratio without fee waivers to compare costs for two different funds. You’ll find the relevant numbers in the Financial Summary section of your fund’s prospectus (don’t forget to check the table footnotes.) The Securities and Exchange Commission’s mutual fund cost calculator can help you with some of the math.

Want a little help sorting out fund selection choices? Financial coaching can make the difference between fund changes that really make and save you money, and changes that just create more headaches. Schedule an appointment today.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Past results are not indicative of future performance. Outside sources used in this article are believed but not guaranteed to be accurate. Examples provided are for illustrative purposes only and are not representative of intended results that a client should expect to achieve.