Avoid Mutual Funds with High Turnover Ratios

Sometimes it’s easy to forget what you set out to do. Many investors simply think they have to get the highest return possible. Instead, they forget that the goal is to end up with the most money after taxes. That’s why it’s hard for them to believe that they can actually get wealthier by owning a fund that generates 12% growth with no turnover than one that has 17% growth and 100%+ turnover. The reason is that age old bane of our existence: Taxes.

Obviously, if you are investing solely through a tax free account such as a 401k, Roth IRA, or Traditional IRA, this is not a consideration, nor does it matter if you manage the investments for a non-profit. For everyone else, however, taxes can take a huge bite out of the proverbial pie, especially if you are fortune enough to occupy the upper rungs of the income ladder. It’s important to focus on the turnover rate – that is, the percentage of the portfolio that is bought and sold each year – for any mutual fund you are considering. Unless it is a specialty fund such as a convertible bond fund where turnover is part of the deal, you should be wary of funds that habitually turnover 50% or more of their portfolio. These managers are renting stocks, not buying businesses; such figures seem to convey that they are extraordinarily unsure of their investment thesis and have little solid reason for owning the investments they do.

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