How to Choose a Mutual Fund, Part II
What’s the value of knowing a Mutual Funds Turnover rate? What is Turnover Rate? How does it help you pick a mutual fund, and does it help predict performance?
Turnover rate is how much a fund turns over its portfolio. How much buying and selling actually takes place within the fund over the course of a year.
A study by Value line provided evidence that the turnover rate of a mutual fund has a direct link to Risk and Return. In the Study, Value line found that there is a relationship between turnover rate and the funds’ performance. Both in low-risk portfolios and high-risk portfolios.
What was really interesting was the data found that High turnover in high-risk funds was an indication of higher returns. Even more interesting was the fact the Low-Risk Funds with High turnover had the opposite effect, lower returns.
Turnover Rate provides an outside view into a manager’s style. How does this help? If suddenly there is a sharp increase or decrease in Turnover, you better pay attention because the manager's style may have changed.
Chasing this year’s Top-Performers
Being a Passive Long-term investor can and should create you a fortune, IF you stay out of your own way.
One of the ways to stay out of your own way is to avoid the temptations of chasing “This Year’s Top Funds”. Chasing the top fund can and usually does distract from your long-term objective of creating wealth through long-term growth, Capital Gains, Dividends and Interest reinvesting back into your fund.
If you choose this years or last year’s Top Performing fund, you need to understand that as a top performing fund, you usually get a lot more volatility (ups and downs).
The other and even more important thing to understand is that the inevitable is about to happen. Top funds in any given year are almost never the top fund the next year or two. Even the best funds have bad years and fall out of favor and in the short-term (1-3 years) produce average returns. If you follow the rules laid out in this post or in my Course, you’ll learn its more important to sit with a Fund through many market cycles. The Above Average Funds we look for, bounce back and continue to produce returns that made us pick them in the first place. The investors that jump around and Chase returns lose out on Reinvestment opportunities and almost always sell their “Top” fund towards its low and reinvest again in the next Top Fund at or near the top. This vicious cycle repeats itself over and over and investors wonder why they cannot become wealthy.
Tip: The Great Peter Lynch of Fidelity Magellan fame even said in his book “Beating the Street”: “Concentrate on solid performers and stick with them.”
When being “Cheap” counts in the Stock Market
If you’ve ever attended one of my Active Stock classes, you’ll remember that I preach, “you get what you pay for” when it comes to investing in individual stocks. Not so with Mutual Funds.
John Bogle, the Chairman of Vanguard has made a fortune for himself and the investors that entrust their money with his firm. Vanguard revolutionized the low fee Mutual Fund Industry. Mr. Bogle once said, “There’s no magic, but when you invest with low costs, you have something”.
An example Mr. Bogle gave was this:
If you invest $10,000 at 10% annual rate of return will turn your original investment into $67,200 after 20 years. If you are wise enough to choose a low-cost Fund of say 0.2% your return ends up being 9.8% annual real return of a true total of $64,800.
However, if you choose a Fund with a higher Expense ratio of say 2%, your Real average rate of return is now only 8%, leaving you $46,600.
I don’t know about you but I’m not giving up and extra $20,200!!
Tip: Pay attention to Expenses, not all Fund Families offer low expense ratio’s.
One of the keys to growing your money and creating real wealth is, make sure you have your Fund company or Brokerage Firm Reinvest your Dividends, Interest and Capital gains. Refer to a previous post on this very subject. The power of reinvesting gains and dividends.
Until next time, Be the smartest Investor in the room.
Welcome to the Nerdery,