Can You Do a Stop Loss With Mutual Funds?
The function of an open-end mutual fund prevents the use of stop-loss orders. A stop-loss is used in stock market investing to sell a stock that has declined to a pre-set price. The idea is to sell before the price drops even further. Since a mutual fund is a diversified, managed product, the kind of sharp drop a stop-loss protects against is much less likely.
Mutual Fund Share Prices
The official term for a mutual fund's share price is net asset value. A fund calculates the NAV by dividing the value of stocks and/or bonds the fund holds divided by the number of shares owned by investors. The vast majority of mutual funds calculate the NAV once a day, after the stock and bond markets have closed for the day. The share price you look up for one of your funds is based on what happened in the markets during the previous business day.
Selling Mutual Fund Shares
A couple of factors concerning how a mutual fund sale is handled prevent the use of stop-loss orders. Mutual fund share purchases and sales go through the fund company and not an investment broker. It is with a brokerage account that you can set up a stop-loss order, and mutual fund companies do not offer this service. Also, when you sell fund shares, you do not know at what price the sale will go through. All of the buy and sell orders for the day are completed at the NAV that is calculated after the market closes.
Mutual funds should be viewed as buy-and-hold investments and not as securities where you trade in and out to catch price swings. There are more appropriate types if investments if that is your plan. However, that does not mean you cannot sell your mutual funds if it looks like the market is in for a big decline. You can set mental stop-loss levels using the stock market averages such as the Dow Jones Industrial Average or S&P 500. When the stock index drops below your mental stop-loss you can send an order to sell your mutual fund shares.
ETFs vs. Index Funds
If your mutual fund investments are in index funds, you may want to look at exchange-traded funds as an alternative. You can find one or more ETFs that will track the same index as the index mutual funds you currently own. Since ETF shares are purchased through a brokerage account and trade on the exchanges, you can set stop-loss orders on ETF investments.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.