A fund with a higher turnover ratio purchases and sells more stocks, bonds, and other financial instruments during a given period than a fund with a lower turnover ratio. More transactions mean more fees. Because using speculation, and gambling to manage funds is a poor investment philosophy, it’s wise to be wary of funds with a high turnover ratio.
Conversely, a fund with a low turnover rate incurs fewer transaction fees and is more likely to be operated by a fund manager who is tracking the market. Funds with a low turnover rates also offer significant tax savings considering that each time a fund manager sells a stock or bond, he must report the income earned as a taxable gain. These capital gains could be passed on to the fund’s shareholders through higher fees being paid from the fund’s income.
If your funds are going to be held in a taxable account, you may want to consider “tax-managed funds” that engage in strategic trading to minimize taxes.
According to Stephan Horan of the CFA (Certified Financial Analyst) Institute, the trading costs of stock funds amount to 2–3% of assets each year. These fees include advisory fees, operating expenses, sales costs, and marketing and other fees. These fees have to be paid even when you lose money in the fund. If the fees total 3%, the fund has to earn 3% just for you to break even. And that’s before accounting for inflation.