Now’s a good time to review your portfolio

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Mark Jewell

Mutual funds have been put to the test.

Over the last three years investors saw their balances nose-dive, then edge back toward prior heights. But few investors have fully recovered.

On the bright side, all that drama should make it relatively easy to perform an annual portfolio checkup, to decide which funds to keep and which to cast out.

How a fund performed through meltdown and recovery are good indicators of how it will fare from here, whether the current rally has legs or not.

Consider selling funds that took a steeper dive than their peers when the market was tumbling, then lagged during the recovery as well. If a fund fared well through both halves of that volatility, stick with it.

“I can’t think of anything fundamentally decent that hasn’t outperformed in at least one of those two environments,” said Christine Benz, personal finance director with fund tracker Morningstar. “The last three years have provided a terrific lens through which to view what your holdings are, and what kind of performance you can expect them to deliver.”

How to check out funds

Examining a fund’s three-year record is one quick test, but it shouldn’t be the only one. Here are seven checkup tips, including special considerations for 2011:

1. Keep short-term performance in perspective: Evaluating a fund’s performance over more than three years is important, especially if it’s one you expect to stick with for decades.

"Don’t discard any fund if it has one bad year," said Cliff Caplan, a financial planner and president of Neponset Valley Financial Partners in Norwood, Mass. "But if I see three years in a row with questionable performance, then I have a problem.

2. Use the right performance yardstick: Assess a fund’s performance only against its peers. It’s misleading to compare funds investing in different segments of the market.

For example, performance can vary widely between a fund specializing in stocks of medium-sized companies and one focusing on bigger companies. That can be true even if both emphasize companies with the same earnings growth characteristics.

Mid-cap growth funds have averaged a 22 percent gain this year, compared with 14 percent for large-cap growth funds. Comparing funds in these two groups is apples-to-oranges.

3. Consider dropping what’s been hot lately: There’s no certainty that yesterday’s champs will become tomorrow’s laggards, or vice versa. But market shifts are to be expected.

This year, funds specializing in small-company stocks have given investors an average return of more than 20 percent. Funds that specialize in stocks of real estate investment trusts also deserve special scrutiny after their average 21 percent gain.

4. Stick with a long-term plan: Be careful not to disrupt the balance of your portfolio between stocks and bonds. Maintain a long-term plan that accounts for your age, income needs and tolerance for risk.

Benz recommends rebalancing if the stock or bond portion of your portfolio has veered 5 percentage points or more off target. For instance, you may want to ease back on stocks if market gains have left you with 65 percent in stocks, rather than an intended 60 percent.

If you haven’t rebalanced within the past three years, you may not need to. That’s because the market recovery has gone a long way — but not all the way — to restore balance in portfolios that had become bond-heavy after stocks plunged in 2008.

5. Look beyond stocks vs. bonds: Don’t make a change without determining whether it might leave you under- or overexposed to certain segments of the market.

For example, ditching a large value fund in favor of a small growth fund might be problematic. Your portfolio could lag if big companies with steadily growing earnings surge while smaller companies hit a rough patch. Keep an appropriate mix of bond holdings with short-, medium- and long-term maturities, and diversify among corporate and government debt of varying credit quality.

6. Examine factors other than performance: If a fund’s management has changed, study the new arrival’s credentials to gauge whether they’re up to the task. If the managers have shifted the fund’s investment style — by veering from small-company stocks to large, for example — consider whether the move might run afoul of your goals.

If the fund has raised the ongoing management fee, consider finding a comparable fund with a lower expense ratio.

7. Don’t overdo it: If you’ve got a sound long-term plan, it’s generally better to make no changes or only minor ones each year. Potential pitfalls include unintended transaction costs or tax penalties.

While it’s generally cheaper to move around than it used to be — consider that companies like Vanguard, Fidelity and Charles Schwab now offer commission-free trades of certain exchange-traded funds — frequent moves only increase the chance of a misstep.

— AP