Your Portfolio Turnover Rate Has Tax Implications

Do you know your portfolio’s turnover rate?

When you use the term “portfolio turnover rate,” you’re usually referring to the trading activity that occurs in a mutual fund over the course of a year. A fund with a high turnover rate likely trades more frequently than one with a lower turnover rate. The Securities and Exchange Commission requires mutual funds to publish their portfolio turnover rate.

A lower turnover rate is a good indicator of a fund’s tax efficiency: When securities in a fund’s portfolio are frequently bought and sold by portfolio managers, the fund’s shareholders have to pay more taxes. Even if you do not sell or exchange your fund shares, you must pay taxes on distributions paid to shareholders by the fund itself.

You can expect to see some deviation in turnover according to the type of fund you’ve invested in.

For example, value-style equity funds – which often invest in out-of-favor stocks that are expected to come back into favor – usually have relatively low portfolio turnover rates; the strategy involves holding on to a stock until the market recognizes its value, which could be a long time.

Index funds – which track a particular index such as the S&P 500 – tend to have limited portfolio turnover because the stocks that make up their indices change infrequently.

Check out your portfolio’s turnover rate. You may be surprised what it reveals.

The legal and tax information contained in this article is merely a summary of our understanding and interpretation of some current provisions of tax law and is not exhaustive. Consult your legal or tax advisor for advice and information concerning your particular circumstances.

The Greatest Investment Risk: Doing Nothing

Some people believe they risk losing some or all of their money by investing. But did you know that not investing could be even riskier?

Let’s say a 35-year-old has decided to invest for her retirement and is putting $750 a month (a total of $9,000 a year) in a tax-deferred account such as a 401(k).

She’s convinced the bull market will halt suddenly, so she’s invested her money in a low-risk investment vehicle earning 6% a year.

Flash forward 25 years. This investor is about to retire and has accumulated roughly $523,000. Will it last another 20 years or so?

Perhaps not. After 25 years, $523,000 is equivalent to $244,000 (assuming 3% annual inflation). And when you take out what is owed in taxes, the total dwindles even more. It may not be enough to live on for 20 years.

The moral of the story: Don’t let all your savings sit in a checking or savings account because you fear risk.

To build a diversified portfolio, you should consider investing in individual stocks and bonds as well as cash or in mutual funds that hold these asset classes.

Of course, investing more aggressively isn’t an appropriate strategy for all investors. Returns are not guaranteed. But it is an option to consider.

Also, remember, diversification doesn’t end at having a mix of stocks, bonds and cash. There are many types of equity investments: growth, value, large-cap, small-cap, international, domestic.

There are also many types of bond investments, from municipal to high yield. And at any given time, one type tends to outperform the others. So be sure to consider all your options.

One option you may not want to consider is letting your money languish because you are afraid of risk. Your financial advisor can help you compare options to get the most from your hard-earned savings.