Your investment portfolio is lined with all types of mutual funds. You have them in your 401k, your Roth IRA, and your investment account. If you happen to notice a newsletter from your 401k custodian that states that one of your mutual funds you own is on a “watch list“, and now you’re wondering what the he** that means. Does that mean that they are watching it because they think it’s getting ready to take off? Or take a dive?
It’s important that you understand what it means when one of your mutual funds is placed on a watch list and perhaps more importantly what it does not mean. Being on a watch list, as the name would imply, simply means the over seeing body of the 401k plan (could be a 457 plan or 403b, too) believes there is good reason to watch this fund more closely. Being on a watch list does not mean you should immediately sell your mutual fund shares. It does mean that you should be watching it more closely and consider selling that mutual fund if it consistently under performs.
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Why are funds placed on the watch list? Mutual funds can be placed on the watch list for several reasons. Why a fund is on a watch list is more important than the mere fact that it is on the watch list. The most typical reasons are as follows:
1. The Mutual Funds Performance or Lack Thereof
The most common reason a fund is placed on the watch list is poor performance relative to it’s appropriate market benchmark and/or peer group. When signs of relative under-performance appear the fund will typically be placed on a watch list. Personally, performance is something that would really make me take a closer look. How long has it underperformed? If we’re talking consecutive quarters, it might be time to dump it and move on.
2. How Risky is the Mutual Fund?
Less obvious to many participants is the risk that a fund manager incurs. If a fund becomes too volatile it could be placed on a watch list. If your stomach can handle the ups and downs of the fund, consider shifting to something more conservative.
3. Returns for the Amount of Risk Taken
What returns has the fund manager been able to deliver relative to a risk the fund has incurred. If the manager is unable to deliver adequate return for risk taken they could be tentatively be placed on the watch list.
4. Has the Mutual Funds Investments Had a Major Overhaul?
Is the fund manager investing the money in a way he or she said. If you invest part of your assets in an aggressive fund that is supposed to be investing in stocks or small growth oriented companies, then you want the manager to do just that. The funda should be monitored to make sure the manager’s portfolio reflect what was communicated that the manger said they would be investing into.
5. Internal Operations.
There are many operational reasons for placing a fund on the watch list. For example the manager of the fund could leave. Remember when you purchase shares of a mutual fund what you are really doing is hiring a professional portfolio manager to invest your money. If that manager leaves you should watch the fund closely. Ever heard of Peter Lynch? He used to run the Fidelity Magellan fund a few decades ago and it was THE fund to own. Lynch later left the fund and the Magellan fund became a lack luster performer, yet many people still hang on the the name. When it comes to mutual funds, it’s not always the name; it’s the man or woman behind it.
There could also be firm level issues and so this can include issues such as regulatory violations, internal management or merger acquisition.
Have you had one your mutual funds be placed on a watch list? What did you do about it?