One of the more difficult things to do when managing investments is to make changes. This is true whether you own individual stocks and bonds, or mutual funds.
Some people like to follow arbitrary guidelines when making sell decisions. For example if a stock drops 10 percent that is a signal to sell.
The problem with that approach is that oftentimes the reason for the drop is because the market or the respective industry is falling a similar amount. Before you sell you should determine whether there is news that is specific to the company.
Other times some investors make decisions based on what they paid for a stock or mutual fund. This is appropriate if the holding is in a taxable account, where you have an incentive to recognize losses and limit realized gains.
On taxes it should also be noted that California taxes capital gains at ordinary income rates, which is different versus the IRS.
If the investment is in a retirement account, what you paid for the security is really irrelevant. For example waiting for a stock to get back to even is not a reason to continue holding the company.
The decision should be which company has the better potential, the company I presently own, or a different security.
When making investment changes it is important to consider the trading costs involved. If someone uses a discount broker, the trading costs might appear to be fairly insignificant.
Typically the cost might be $5 to $10 per trade. In addition there is a bid ask spread, which for actively traded stocks is only $.01. For example someone would pay $40.01 to buy a given stock and would sell it at $40.00.
With low cost trading, this has led to a proliferation of active traders. Unfortunately this had not led to better investment results.
A study of the most active traders at discount brokerage firms showed that they had significantly poorer performance versus the average investor.
This was likely due to the fact that few people can time the market well, and small trading costs add up over time.
For those who are investing in mutual funds there are trading costs within the fund. If a fund has a high turnover ratio, they will be incurring more trading costs relative to a low turnover fund.
The reason active managers tend to underperform index funds is that in addition to having a higher expense ratio they are incurring greater trading costs.
The costs to buy individual bonds can be quite significant. While bond trades do not incur a commission like stocks do, there is a very significant bid ask spread that can be several percentage points for corporate and municipal bonds.
For U.S. Treasurys the cost to trade is less plus you can purchase directly from the government at no cost.
For most investors with bond holdings it is generally best to invest in a fund, unless you are just buying U.S. Treasurys, or have a very large portfolio.
The disadvantage of U.S. Treasurys is that their yield is lower than corporates because of their better liquidity and safety. That is why it is generally best for most people to invest in a diversified bond fund that has a relatively low expense ratio.
In a typical 401(k) retirement account there are no costs involved in making investment changes. That is you can switch funds without incurring trading costs, and there are no taxes involved.
Some plans limit the frequency you can trade plus in certain funds you may not be able to re-enter after selling for a period of time.
In general you should make changes in your retirement account when your investments start to deviate from their intended ranges. If you are using target date funds this would be done automatically.
Overall it is generally best not to make too many investment changes. You should still pay attention to your investments and look at your statements.
However, even when turnover costs are low you would likely not benefit from more frequent trading.
