Is Turnover the Key to Wealth?

I recently read a great article in SmartMoney magazine by Roger Lowenstein, one of my favorite financial writers, and the author of the wonderful book Buffett: The Making of an American Capitalist. I found a lot to agree with in Lowenstein's piece:

  • He recommended broad-market index funds for most investors. (We've done so, too, at The Motley Fool -- for a long time. Learn more about index funds and funds in general.)
  • He said he wasn't a big fan of market-timers. I agree, since it's very hard to be right consistently.
  • He explained that it's useful to look at a mutual fund's turnover when evaluating it as a possible receptacle for your hard-earned dollars. (Turnover reflects the buying-and-selling activity in the fund. On average, a fund with 100% turnover replaces all of its holdings each year, so it's clearly not holding them with much long-term conviction. The average domestic stock fund has a 97% turnover rate.)

Lowenstein went on to explain how studies have shown that high-turnover funds tend to have higher-than-average fees and lower-than-average performance -- a yucky combination, don't you think? He recommended that we look for funds with turnover rates of no more than 33%.

My mind then wandered to Fidelity's Magellan Fund (FUND: FMAGX  ) , which used to be the largest fund around before losing ground due to lackluster performance. (I was once a shareholder.) With nearly $50 billion in assets, the now-closed fund gained 7.5% in 2004 and 6.4% in 2005. Its top holdings included (as of a few months ago) UnitedHealth Group (NYSE: UNH  ) , Nokia (NYSE: NOK  ) , General Electric (NYSE: GE  ) , Google (Nasdaq: GOOG  ) , and Johnson & Johnson (NYSE: JNJ  ) . Its turnover rate? 74%. Then I thought of Bill Miller's exceptional Legg Mason Value Trust fund, which has beaten the S&P 500 for 15 years in a row. Its turnover rate? Around 13%. (Interestingly, it also sports shares of UnitedHealth Group and Google.)

If you suddenly find yourself in the market for market-beating funds with low turnover rates (not to mention great managers, low fees, and top-notch track records), we'd love to introduce you to some, via our Motley Fool Champion Funds newsletter. Try it for free and see which funds our analyst Shannon Zimmerman is recommending and has recommended -- and why. Together, his picks have more than doubled the market's return (as of the last time I checked), gaining an average of 16% vs. 6% in the same time period.

Learn much more in these Zimmerman articles:

Longtime Fool contributorSelena Maranjianowns shares of Johnson & Johnson and Berkshire Hathaway. UnitedHealth is aMotley Fool Stock Advisorpick, while Johnson & Johnson was recently selected byMotley Fool Income Investor. The Fool has adisclosure policy.

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