Dan writes in to ask,
“I have a portfolio with a large brokerage firm. It’s primarily invested in individual stocks, with a handful of mutual funds thrown in as well. The individual stocks have performed very poorly. The mutual funds have performed better, but (I’m now learning) they have very high expenses and they’ve underperformed the market by a wide margin.
I know that I want to move my money. I’ve been reading on your blog and in several books about using index funds to invest with low costs. But if I sell everything now, after a period of very poor performance, wouldn’t I be selling low? Isn’t that the opposite of prudent investing? Wouldn’t it make sense to wait a few months to see if the stocks come back?”
I get lots of emails like this. People realize that their portfolio is a mess and that it has performed very poorly. Sometimes they even know exactly what they’d like to switch their portfolio to, but they are still reluctant to make the switch because they don’t want to “sell low.” They don’t want to “lock in” their losses.
Look Forward, Not Backward
The problem with this line of thinking is that, tax considerations aside, it’s irrelevant how your portfolio has performed in the past. The only thing that matters is how to make it perform as well as possible in the future.
It can be helpful to look at the situation this way: If your entire portfolio was in cash right now, how would you invest it?
However you answer that question is (in most cases) how you should invest your portfolio.
In other words, either:
- You have a good reason to think that your current holdings will outperform a lower-cost, more diversified portfolio in the future, or
- You do not.
If you have such a reason, why switch your portfolio at all? And if you don’t have such a reason, why wait to make the switch?
And remember, the mere fact that a stock has declined in the recent past (or that a mutual fund has had sub-par performance) is not a reason to think it’s going to have better-than-average performance in the future.
There’s a potential exception for investors who are currently invested in funds that have contingent deferred sales charges. These charges are commissions on certain share classes of certain mutual funds that are charged if you sell the fund within the first several years. Because they decrease (and eventually disappear) over time, it sometimes makes sense to wait before selling the fund.
Alternatively, if the investments in question are in a taxable account, it can sometimes make sense to stick with your current holdings in order to avoid paying taxes on large capital gains, even if those holdings are not something you’d buy if you were just getting started today. However, if your current holdings have unrealized capital losses, “selling low” would provide some tax savings — giving you all the more reason to make the switch now.