Short term cutting losses in a long term investment

Question

I've only recently bought some mutual funds last year. Since then, my mutual funds' value has been losing money. When I set up this fund with my broker last year, for my investment portfolio I selected the following options:

• risk: aggressive
• investment timeframe: 10 years +
• likelyhood of withdrawal: unlikely

I still stand by what I selected. But recently, I got into a discussion with a friend about whether or not it is better to take out take out your money to cut your losses and reinvest later or is it better to just ride it out.

I can see the benefit of what he means by cutting losses and reinvesting later, as long as the commission rate is smaller than future amount that you would lose.

But I've also heard from many people that it is best to just ride it out during a bad market. My question is what is their reasoning for stating this? Does it depend on contexts (ie, stocks vs mutual funds, timeframe, etc?).

I understand that in the long-term, stocks have a high chance of going up, despite the many fluctuations they experience in the short term. But considering my friend's POV, why shouldn't I just take out my money now and reinvest later? Is this type of investing style more prevalent in stock investors than mutual fund investors?

Answer 1

What you are suggesting would be the correct strategy, if you knew exactly when the market was going to go back up. This is called market timing. Since it has been shown that no one can do this consistently, the best strategy is to just keep your money where it is. The market tends to make large jumps, especially lately. Missing just a few of these in a year can greatly impact your returns. It doesn't really matter what the market does while you hold investments. The important part is how much you bought for and how much you sold for.

This assumes that the reasons that you selected those particular investments are still valid. If this is not the case, by all means sell them and pick something that does meet your needs.

Answer 2

If you are investing for 10 years, then you just keep buying at whatever price the fund is at. This is called dollar-cost averaging. If the fund is declining in value from when you first bought it, then when you buy more, the AVERAGE price you bought in at is now lower. So therefore your losses are lower AND when it goes back up you will make more.

Even if it continues to decline in value then you keep adding more money in periodically, eventually your position will be so large that on the first uptick you will have a huge percent gain.

Anyway this is only suggested because you are in it for 10 years.

Other people's investment goals vary.

Answer 3

What might make more sense is to 'capture' your losses. Sell out the funds you have, move into something else that is different enough that the IRS won't consider it a wash sale, and you can then use those losses to offset gains (you can even carry them forward) You would still be in the market, just having made a sort of 'sideways move'. A month or two later (once you are clear of wash sale rules) you could shift back to your original choices.

(this answer presumes you are in the US, or somewhere that lets you use losses to offset gains)