When it comes to investing for the long run, it is always better to make a few good investments and then sit on your assets.
In practical terms, turnover in an investment portfolio or fund is loosely defined as the percentage of a portfolio’s or fund’s holdings that have changed over the past year. To be sure, the vast majority of investment advisors, mutual fund managers and hedge funds love to trade their clients’ portfolios. In fact, amazingly, the median mutual fund turnover rate now stands at over 80%!
A turnover rate this high usually means that a manager is engaging in a considerable amount of buying and selling of securities. There are numerous reasons for this, including reactionary response, inherent conflicts of itnerest and most notably, manager overconfidence. Unfortunately, research has shown that high turnover investment strategies almost always lead to long-term under-performance. Higher turnover rates usually coincide with short-term investment horizons, higher commission levels and considerable tax consequences.
Turnover is important for several reasons:
- On average, performance tends to deteriorate as funds’ turnover rates increase,
- It can be an indication of an investment manager’s true strategy, more specifically buy-and-hold versus trading on short-term market fluctuations,
- Funds with higher turnover (implying more trading activity) incur greater brokerage fees associated with implementation of their trades,
- Funds with higher turnover tend to generate more capital gains than low turnover funds because high-turnover funds are constantly realizing the gains,
- A material change in a fund’s general turnover pattern can indicate changing perception of market conditions, sector rotation, potential market timing, a new management style or a change in the fund’s investment objective. (1)
Studies have shown that high-turnover funds and portfolios tend to have higher-than-average fees and lower-than-average performance – certainly a sub-optimal combination. In fact, approximately 90% of the highest turnover expense mutual funds under-perform their respective benchmark and peer group over a given 10 year period or, even worse, close their doors (2). Simply put, on average the more you pay the more you under-perform. These studies reveal that investors should seek out and invest with managers that employ long-term vision, those whose turnover rates are no more than 33% (3).
At Doyle Wealth Management we seek to invest in attractive stocks that we believe will out-perform over the long run…stocks that we will rarely have to sell (in fact, we hope, never!). The typical target investment horizon for each and every stock we invest in is 3 to 5 years. In fact, our 5-year annualized turnover rate is an impressive 14% , ranking us in the top 14% of all equity fund managers (4).
As an investor, you should seek out an advisor that pursues a long-term, low turnover investment strategy…you will increase your chances of out-performing while reducing your tax bill. This double whammy will help you sleep better at night and lead to better returns in the long run.
1. (c)2015 Morningstar
3. Roger Lowenstien, SmartMoney Magazine
4.(c)2015 Morningstar, Doyle Wealth Management, Inc. Composite Data