For example, a fund that stresses tax efficiency that has a turnover ratio above 60% is probably not doing a very good job of minimizing taxes, unless the majority of sales were for the purpose of dumping losing picks-which, of course, is another bad sign. ![]() A fund’s turnover ratio can in fact be an indicator of whether a fund is following the investment objective that is stated in its charter. New portfolio managers that replace experienced ones also may choose to trade with greater frequency in an effort to distinguish themselves from their predecessors. In other cases portfolio managers realize that they have made poor choices and then must sell holdings and replace them with other picks in an attempt to recoup losses. Some portfolio managers attempt to outperform the market through constant trading-which, as mentioned previously, seldom works over longer periods of time. There are several reasons why a fund might have high turnover, and in most cases none of them are particularly good. This means that these gains will be taxed as ordinary income, and shareholders will be taxed at the rate equal to their highest marginal tax rate.Īlthough taxes and expenses are certainly significant factors to consider when it comes to portfolio turnover, perhaps the most important measure that it provides is how well the fund is being run behind the scenes. And in most cases, the gains that are posted will be short-term, since they were held for less than a year. This can be bad news for retail shareholders who do not hold their funds inside an IRA, employer-sponsored retirement plan or variable annuity contract. Higher turnover means a higher number of reportable gains and losses that are passed on to shareholders at the end of each year. Lipper published a study several years ago that estimated the average mutual fund carries transaction expenses of about 0.15% per year-which can cost investors with larger share holdings thousands of dollars over time.Īnother negative aspect of high portfolio turnover comes from the tax man. Furthermore, commission costs are not included in the fund’s expense ratio that is listed in the prospectus they are typically listed separately as a total dollar figure in the fund’s Statement of Additional Interest ( SAI). Money market funds are low-risk mutual funds invested in safe short-term assets like Treasury securities, CDs, and municipal bonds. This is one of the reasons why index funds have become so popular, as many investors have come to realize that index funds have virtually no turnover and usually outperform the vast majority of managed funds over longer periods of time. Mutual funds have to pay commissions on their buy and sell trades just like individual investors, and this expense lowers the returns posted by the fund in the same manner. One of the most obvious effects of high turnover is from the corresponding increase in transaction costs. ![]() Portfolio turnover can impact a mutual fund’s overall performance in several ways.
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