When you invest in a mutual fund, you probably take time to determine which fund best meets your investment goals and when you should invest.
But how much time do you devote to redemption decisions: whether you should sell fund shares, which you should sell, why you should sell them and when you should sell them?
A new Investment Company Institute study, "Understanding Shareholder Redemption Decisions," sheds light on the thoughts investors who redeemed equity and bond fund shares between May 1991 and March 1992.
Scanning the study's highlights, you can see how your redemption pattern compares with those of fund shareholders who filled out the ICI's eight-page questionnaire or were interviewed on the phone. And insights from the data may help you avoid redemptions that result in taxable capital gains, capital losses, or missed opportunities for future gains.
But first, a word about terminology. When you sell shares of a fund and invest that money in another fund within the same family, it's called an "exchange" by the industry. When you sell but move the money to another fund family or don't reinvest, it's called a "redemption."
Although both types of transactions actually involve share redemptions, the study deals only with redemptions as more narrowly defined. (They are of greater interest to ICI members. By better understanding why people redeem, they hope to devise ways to reduce redemptions and retain assets.) No one knows whether a study of exchanges would yield similar findings.
Some 70 percent of those surveyed who closed fund accounts -- called "full redeemers" -- and 80 percent of "partial redeemers" said they made their decisions to sell without being influenced by anyone. The rest were influenced by brokers or financial consultants or by something they read. (No question was asked about whether people were influenced by what they heard on radio or TV.)
Full and partial redeemers differed in several ways, and people who owned directly marketed -- usually no-load -- funds redeemed more frequently than those who bought from sales people.
Some 80 percent of full redeemers sold for strategic reasons: Their investment goals had changed, they wanted funds offered by other companies, they were concerned about market conditions, or they decided to take taxable gains or losses.
About 55 percent closed their accounts for reasons related to the funds: dissatisfaction with performance and/or high fees or costs (the latter reason was cited by nearly one in five who redeemed sales force-sold funds). Only 34 percent said they needed the money, mostly to make large purchases or pay household bills.
In contrast, 75 percent of partial redeemers sold shares because they needed the money, 49 percent sold for strategy reasons, and only 16 percent sold for reasons related to the funds. That would explain why nearly all reinvested in the same funds when possible.
Since surveyed shareholders typically owned shares in more than one fund, why did they choose particular funds for redemptions?
Among full redeemers, 46 percent felt the funds' expected returns were lower than those on other sources of cash. A similar share of partial redeemers said they picked the funds that were the most convenient or liquid sources of cash.
Only small minorities -- 16 percent of full redeemers, 22 percent of partial redeemers -- said they had invested in a fund for a specific purpose and were redeeming for that purpose.
Both full and partial redeemers had held the shares they redeemed for a median of five years -- "especially positive," ICI commented -- but nearly one-quarter of each group had held them for two years or less.
All of which raises some points for your consideration:
* Almost everyone has unanticipated needs for money: loss of a job, major medical expense, and so forth. But it's regrettable to have to disturb long-term holdings of good bond or equity funds to meet them. That's why you should have reserves in savings accounts, money market funds, and -- if appropriate -- short-term bond funds.
* Anticipated needs for money are something else. You can develop a timetable for gradually redeeming shares of equity or bond funds, perhaps cashing in fixed amounts at regular intervals -- the flip side of dollar-cost averaging -- instead of speculating on market tops. Of course, if you expect you'll need the money within a couple of years, you shouldn't invest in long-term funds in the first place.
* Investors who sold in 1991 because expected returns were too low might have been in below-average funds, had unrealistic expectations, or had too little patience. The year turned out to be a good one for both stock and bond markets.
Failure to realize expectations also may be due to investors having decided, or been persuaded, to buy inappropriate funds. It's crucial that a fund's investment objectives and risk level -- whether an aggressive or nonaggressive equity fund, a long- or short-term bond fund -- be compatible with your goals and risk tolerance.
& 1993 By WERNER RENBERG