Turning your mutual fund lemons into lemonade

— -- We admire people who look into the eye of adversity, dig in their heels and persevere, no matter what the odds. But in investing, it's best to stare defeat in the face, lace up your sneakers and run screaming into the woods.

Much of financial literature lauds the virtue of long-term buy-and-hold investing, and it's true: If you invest in stocks over very long periods, you typically earn more than you would from less risky investments, such as bank CDs and bonds. If you're willing to hang on through the tough times, your investment rewards can increase with the risks you take. That said, there are some perfectly good reasons to sell, too.

For example, while it's all well and good to hold a diversified portfolio of stocks through booms and busts, specialized stock funds and individual stocks carry far more risk than, say, a fund that tracks the Standard & Poor's 500-stock index.

The axiom that "rewards increase with risk" has limits, just like, "The faster you drive, the sooner you get there." If all you had to do to achieve wealth was to take on more risk, then all financial wisdom would boil down to buying lottery tickets.

If you own stocks or funds with above-average risk, selling is a better option than holding through catastrophic losses, which can lead to the permanent destruction of wealth, not the creation of more of it. After all, if you lose 50%, you then have to earn 100% just to get even.

And a long-term investment outlook doesn't necessarily mean keeping every holding until the bitter end. Some companies become obsolete over time. Of the 500 companies in the index in 1957, for example, only 57 stocks remained by 2007.

In short, there's nothing inherently wrong with selling. And if you hold your stocks or funds in a taxable account, selling has a distinct advantage: You can reap excellent tax benefits from selling your losers.

You can use your losses to offset any amount of long-term capital gains. Let's say you bought 500 shares of Ford 10 years ago. At the time, your shares cost $44.625 apiece, for a total cost of $22,313. At the end of August, you decided you had suffered enough and sold all 500 shares at $4.46 a share. (You didn't reinvest your dividends.) Your proceeds: $2,230 — a loss of $20,083!