June 21, 2006
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.)
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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.