Why High Portfolio Turnover May Be More Costly Than High Mutual Fund Fees

High Portfolio Turnover means higher fees

High portfolio turnover may b more costly than high mutual fund fees. With high portfolio turnover, you've got more taxes to pay. Further, you might completely mis-time your buying and selling.

Everybody should understand by now that high mutual fund fees drag performance down over time. Given the large majority of active fund managers underperform their respective benchmarks (e.g. 7yg~75% underperformed over the past 10 years), paying high fees for underperformance over the long run is silly.

The vast majority of your investment portfolio should be invested in low-cost ETF index funds. I'm talking an 80%+ allocation with the rest to seek multi-baggers if that is your desire.

For example, if you want to gain exposure to large-cap dividend yielding companies, consider VYM, the Vanguard High Yield Dividend ETF with a 0.09% expense ratio, compared to 0.5% – 1.2% for many other actively managed funds. The good thing about holding individual stocks is that there are no ongoing fees.

In a difficult investing environment, fees matter more than ever. But what may be even more important than the ongoing management fee is the fund's turnover percentage.

I'm going to share with you a case study I recently researched for Personal Capital, my favorite hybrid digital wealth advisor about how high fees rob you of your retirement. I'll also give you some insight on how big mutual funds go about selling their huge positions. 

Take a look at three of some of the largest actively run mutual funds in America. All three firms are private. And all the portfolio managers of these funds are beyond wealthy due to the fees they earn.


Largest Mutual Fund Fee Comparison - High Portfolio Turnover


Largest Active Mutual Funds In America Performance - High Portfolio Turnover

A quick analysis tells us several things:

* The 5.75% front load fee charged by the American Funds is incredibly high. Front load is a commission or sales charge applied at the time of the initial purchase of an investment.

In other words, if you invested $100,000 in AGTHX, you would have to pay an up front fee of $5,750, and then an ongoing expense ratio of 0.65% a year.

That's kind of nuts, especially if you decide the fund is not for you the following year. The American Funds employ the brightest people on Earth. But even the brightest people on Earth have a hard time consistently outperforming over the long run. Try not to pay front load fees.

* All funds charge around the same Expense Ratio of 0.64% – 0.65%, which makes me wonder whether there's some collusion going on among the big funds or whether this is just “industry standard.”

* What's missing from the above charts are the fund's respective turnover percentages. They are 45% for the Fidelity Contrafund, 29% for The Growth Fund Of America, and just 12% for the Dodge & Cox International Stock fund.

* The Dodge & Cox International Stock fund's performance of -21.6% over the past year is 16X worse than the Fidelity Contrafund's performance of -1.37%, once again reminding us that paying a fee for a high chance of underperformance doesn't make sense.

High Portfolio Turnover Means Higher Fees

To illustrate why high portfolio turnover could mean higher fees, pretend you are Will Danoff, fund manager of the Fidelity Contrafund with $78 billion in assets under management. You want to sell 100% of your Facebook holding, which equates to 5% of the fund.

1) Cost per share fee.

Wall Street trading desks charge a fee per share to sell. Fidelity owns $3.9 billion dollars worth of Facebook shares (5% X $78B). This equates to 39 million shares selling at ~$100 a share. If Morgan Stanley charges 1 penny a share to sell, the cost comes out to $390,000 in trading commission! Too bad they can't just pay <$10 per trade like retail investors with online brokerage accounts.

2) Block transaction fee.

With an amount this large, a broker will tend to try and arrange a block sale to another interested fund to minimize market disruption. In other words, Morgan Stanley might find one or multiple FB buyers from Wellington, the American Funds, Blackrock, or a large hedge fund to cross the trade and collect a negotiated fee as an agent on both sides.

If Morgan Stanley wanted to risk capital, it could conceivably bid on the $3.9B block of FB at a discount to try and resell at a higher price to other clients if it had balls of steel. But $3.9B is too much stock when compared with Morgan Stanley's balance sheet. Agency transactions are much more common as opposed to principal transactions.

3) Market movement cost.

The biggest cost to Fidelity's Contrafund is likely not the commission costs, but the implication of what selling $3.9B in Facebook stock could do to the stock's share price if no block transaction is arranged.

There is often a leakage when a large fund wants to get out of a large position because multiple people are involved. This is why electronic “darkpools” were invented to keep trading as anonymous as possible. As soon as the Street gets whiff that $3.9B of FB is being sold, traders will tend to front run the sale to get out first.

As a result, instead of selling FB stock at $100 a share, by the time the Contrafund gets out, they might have to sell at an average of $95 a share, resulting in $200 million less in proceeds! High portfolio turnover is detrimental for shareholders.

Only about $3B worth of Facebook stock trades a day on average to begin with (30 million shares traded X existing price). Therefore, selling $3.9B of stock without disrupting the market, will probably take at least 10 trading days if you instruct Morgan Stanley to be no more than 1/10th of the average daily volume per day.

Even if nobody finds out that Fidelity is the seller of $3.9B of stock, savvy traders will still know something is up. The general thinking is that when large amounts of stock is for sale, someone smart knows something bad might be up, and others will tend to sell at the margin without knowing exactly what's going on.

4) Costs to purchase a new position.

Now that you've got $3.7 – $3.9B in proceeds from the Facebook stock sale, you now want to buy a new 5% position for your fund. Or, you might want to spread the proceeds to beef up existing holdings.

You've got to now go through the same process with your institutional broker again. But this time, you will probably have to pay UP for the new shares, especially if the Street gets whiff of your plans. The higher the purchase price per share, the lower your fund's performance.

You could theoretically take months to accumulate your position to cause the least amount of disruption possible, but actively run mutual funds have a fiduciary duty to be fully invested at all times.

If the price of the stock you want to buy moves up 3% higher on average, you've now got to pay $111 – $117M more for the stock + another several hundred thousand in trading commission cost. This is all because of high portfolio turnover.

5) Higher taxes.

Finally, the more a fund trades, the more a fund has to pay in taxes. Theoretically, if a fund held a position forever, it would never have to pay any capital gains taxes, only taxes on dividends.

The short-term capital gains tax rate follows ordinary income tax rates. The long-term capital gains tax rate is at 15% and 20% for most tax payers. Therefore, it behooves investors to hold their positions for at least one year.

High portfolio turnover results in my taxes and more performance drag for shareholders.

Invest In Low Turnover, Low Fee Funds

Anybody who has experience actively trading their portfolio realizes after a while that many of their gains are often negated by their losses. For over 15 years I was an active trader with 10-20% of my investable assets. When it came time to do my taxes, I was often amazed how futile active trading seemed to be. The great majority of time, I would have been much better off simply holding.

A good rule to estimate is that every 10% in portfolio turnover means a negative -0.1% portfolio drag. Therefore, if a portfolio turns over 100% a year, expect a 1% decline in performance on top of the fees you are already paying.

But as we see above with Dodge & Cox International's -21.6% one year performance, even a low 12% turnover ratio can't help if they pick bad stocks! The Vanguard Dividend Yield ETF not only has an expense ratio of 0.09%, but a turnover of 11%. Now that's a winning combination for long term investors.

If you want to see what a fund's portfolio expense ratio and turnover is, simply head over to Yahoo Finance, type in the fund's ticker, and click Profile.

Or, you can analyze your entire portfolio's expense ratio through Personal Capitals free Portfolio Fee Analyzer to see how much you're paying. They suggest a benchmark of paying 0.5% or less in fees. Below is a annual fee analysis of one of my investment portfolios that is at only 0.17%.

Personal Capital Portfolio Fee Analyzer - High Portfolio Turnover
Mutual Fund Fees Using Personal Capital's Portfolio Fee Analyzer
Click “Advisor Tools” after you link your accounts to see the specifics fees per position.

Related: How To Reduce 401(k) Fees Through Portfolio Analysis

Updated for 2021 and beyond. High portfolio turnover needs to be questioned and analyzed before you buy a particular fund.

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29 thoughts on “Why High Portfolio Turnover May Be More Costly Than High Mutual Fund Fees”

  1. Hi I’m in my work 401k plan. It matches but the fees are high….probably cause I’m in a fund of funds that has a target retirement date – symbol is TRRDX with expense ratio 0.75%. Ofcourse it’s suppose to be periodically rebalancing the underlying holdings but I was wondering Is this a good deal for me and other workabees?

  2. FinanceIsEasy

    Nice article Sam. I think both, high expense ratios and high turnover percentage hurt a fund’s return. Front loads are plain LUDICROUS!

    I am a fairly young investor who has always looked for low cost indexed funds with minimum fee and very low turnover (FSTVX or VTSAX). I am slowly starting to believe that there are no mutual gains to be had in a managed mutual fund.

    1. Yes sir. A front load fee is ridiculous, and I know people who pay them! My female friend met a guy at the beach playing volleyball. He was an advisor w/ Edward Jones and got her to transfer her entire retirement portfolio over to them and paid a 5% front load fee. What the hell. Not sure how that guy can live with himself. I told her he took advantage of her, and she’s too meek to do anything about it.

      I hate it when these financial advisors prey on the weak or uninformed.

      1. FinanceIsEasy

        I am not well versed with the wealth management industry. I often wonder how and why the wealth management industry can thrive without many regulations.

  3. High turnover is not necessarily “bad,” it is just a characteristic of the fund. A more aggressive balanced fund will have higher turnover. I would be equally concerned if a fund was not turning over enough to maintain efficiency and balance versus its benchmark.

    I work at a large financial firm and some of the funds we service alphabetically include those in the 22nd letter. It is not unusual for them to dump $8-12 billion but it usually only takes a week to unwind and a lot of the shares get matched internally. This doesn’t happen every day of course. But the commissions are a lot higher than posted. Off the top of my head I can recall $100k on $300M.

    1. That may be true, but if the thesis holds that most fund managers can’t outperform the index (75% don’t over the past 10 years), then trading more just simply creates more tax and trading costs.

  4. Financial Slacker

    I hear you on this. I’ve seen it first hand.

    When I started investing, I worked with an RIA and we had the bulk of our portfolio allocated to just a few funds. The funds then invested primarily in low cost index funds. There was very little turnover, the cost was low, and the performance was as expected. We were pleased.

    Then our RIA retired and we went down a path working with another advisor.

    My Financial Slacker tendencies kicked in about this time as I was more focused on making money and not investing it.

    And unfortunately, the advisor quickly had us invested in over 30 mutual funds paying about 1% in fees (plus an advisory fee) with massive turnover.

    The performance was bad. When the market declined, we went down more. When the market went up, we went up less. We were not pleased.

    We have since corrected the problem by taking ownership of our investments and are now mostly invested in ETFs.

    1. Wow. 30 mutual funds paying 1% in fees + advisory fee each and massive turnover is truly a RIA looking out for himself first and not the client! I wonder how many other clients are getting taken advantage of in this way.

      Glad you’ve rectified and simplified your investment exposure!

  5. Physician On FIRE

    Thank you for the great writeup! I started my taxable fund with a portfolio of random mutual funds and funds of funds with a reputable, but not lowest-cost company. Some were actively managed. As I learned more, I switched to Vanguard Index funds.

    My taxable account now has at least 5x what it had a few years ago, but generates fewer taxable gains / dividends than the original, much smaller portfolio spun off each quarter. Some people love dividends, but they are an enemy to total return when in a high income bracket.

    1. I usually buy dividend stocks in sheltered accounts (IRA, 401k) if possible, especially for REIT dividends which are taxed as ordinary income.

  6. I did hear about the turnover ratio but never paid attention, always used to look at ER. Thanks to Sam for this very informative writing


  7. Think of the tax implications on the Facebook example you’d described if their was a capital gain. The turnover ratio is in correlation to the tax efficiency. Any capital gains taxes paid by the fund eat into your return as the investor. Buy indexes and hold all the way!

  8. Articles like this one illustrate why this is the best personal finance blog on the planet. Real, meaningful analysis regarding a subject I didn’t know existed (fund turnover).

    1. Thanks Matt! It’s easy to write about what goes on behind the scenes and provide some analysis when you’ve spent your entire career in the business. A lot of folks misunderstand the reason for “darkpool” trading. Funds want to trade anonymously so they don’t get front run by other traders. Better entry and exit prices HELP the individual investor in these funds through better performance.

  9. Interesting. I didn’t know Wall Street had to pay soooo much more when trading. I thought the internet revolution made it possible to trade $3.9 billion of stock for $7 like the rest of us normal retail investors. Score one for the little guy I guess. That’s the danger of assuming!

    It makes even more sense why mutual funds under perform now. They are almost set up to fail. It seems like an active retail investor has a huge advantage over the Wall Street firms if he is about as smart. I remember Buffett saying he could get a 50% annual return if he was managing a $1 million portfolio, but he can’t now that he manages so much money.

    1. Yeah, not at all. It would be hilariously awesome for a fund to just pay $7 to trade $3.9 billion of stock, but then there wouldn’t be any market makers left, and trading would come to a halt!

      Larger funds have a smaller universe of stocks to choose from. It’s definitely harder to outperform the bigger you are.

  10. 5.75% front load fee? Wow. Might as well be signing a multi-year lease.

    I’ll stick to my low fee index ETFs, thanks.

  11. So important. It’s crazy to think wealthy investors would waste so much on fees and such. I guess it’s nice to know you have broader access and pros working for you but I have a DIY account for no fees at all and that seems to make a whole lotta sense.

    1. It’s not so much wealthy investors wasting money on fees, it’s institutional investors who have to pay these fees, which ultimately get charged to the RETAIL INVESTOR who puts their money in these huge funds.

      Yes, creating your own portfolio of stocks and bonds carries no fees. Just the minimal fixed transaction costs, which is really nothing if you have a large enough portfolio. Creating your own active portfolio with a minority of your investable assets is worthwhile IMO. I wouldn’t have been able to find my 30 bagger in 2000 if I didn’t! I parlayed the proceeds into a SF 2/2 condo in 2003, and things have done well since.

      1. Ya that is amazing. I think that trade really gave you a great boost in getting your net worth high at a young age. Smart of you not to chase that into other OTC like trades where you could have lost it all back. Most people when they have a realized winner like that don’t have the discipline to not try and repeat it and thereby squander their winnings. Props to you for taking the smart route.

        1. Thanks. I would say I was 80% lucky with the trade though. Things were crazy back then, but finding a 30 bagger that moved within 6 months was just unheard of even during the dot com bust.

          I did initially parlay the proceeds into B2B stocks for a little bit. Lost about $15,000, and then just went all cash. I like the idea of turning ALL funny money into real assets!

  12. Thx for sharing this insight.
    It is not only valuable for fund investors. It makes me also think how to deal with this in my play portfolio. This is by definition a buy-sell portfolio. I will have a look into this, both for my funds and own portfolio.

  13. I think a more costly form of turnover comes in the way of performance chasing. I’ve seen a lot of people buy into mutual funds that have performed well recently but they sell out when the fund has an inevitable period of underperformance. Rather than acknowledging the flaws in performance chasing and switching to an ETF, they repeat the cycle of underperformance. It’s a constant cycle of buying the “winners”, and selling the “losers”. Maybe it’s the chase of trying to be better than average that leads people to continue to make these mistakes.

    1. There’s definitely a lot of “performance chasing” going around. Having a disciplined dollar cost averaging strategy and being a little bit contrarian will help.

      A lot of funds that have been highlighted as “the best funds” tend to get a huge inflow of new money. The new money tends to drag down performance as the fund grows. I like nimbler funds, or just fund ETFs.

  14. Jim @ Route To Retire

    Fees, fees, fees – makes me want to throw up! :-)

    You beat me on the annual fees by 1/100 of a percent! My 401(k) is now at 0.18% – I got that down from about 1% after my jaw-dropping look at the Retirement Analyzer in Personal Capital a few months ago.

    I never looked at the turnover ratio before – never even knew there was such a thing. Now I have something more to do… thanks a lot! ;-)

    You know, most of your readers probably have some kind of financial smarts and might dig into this, but the majority of people out there are just getting robbed blindly. It’s ridiculous and not right, but at least there are people out there helping to spread the word (like yourself).

    — Jim

    1. Hah! Nice. 0.18% is not bad it all. 1% is, especially if the market is returning a negative amount or the market is only up 1-2%.

      I never really looked too deeply into turnover ratios before until my latest research. It makes absolute sense to invest in lower turnover funds. It’s not good for business for Wall Street, but it is better for the investor in such funds!

  15. I haven’t paid much attention to the turn over ratio, either. I know it’s bad and I’ll check my funds now. The good thing is most of my mutual funds are at Vanguard now. They all have low fees and I think low turn over. I don’t like front and back load funds at all. I felt ripped off when I invested in them when I first started investing. Now I always go with no load funds.

  16. Checking turnover ratio is something I hadn’t paid attention to in the past but will now be looking over my portfolio to see how much turn over has happened and make some changes depending on what I find. It is great to get some insight into how the fees are collected and how they effect fund performance over time. Thanks for the great insight FS.

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