Pay Attention to Turnover

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You're all excited -- you've found a mutual fund that looks terrific. And perhaps, because of its strong performance, you're thinking of buying some of its top holdings as individual stocks for your portfolio. If so, be careful.

Consider the Columbia Technology Z (CMTFX) fund. It sports a strong five-year average annual return of nearly 19%, handily beating the S&P 500 by some 10 percentage points. Its manager, Wayne Collette, has been at the helm for six years. A glance at its top holdings reveals names such as Oracle (Nasdaq: ORCL), Qualcomm (Nasdaq: QCOM), and eBay (Nasdaq: EBAY). So what's the problem?

Well, be sure you check out the fund's turnover ratio. No, that statistic isn't about the manager's pastry preferences -- it reflects the percentage of a mutual fund's assets that have turned over in the past year. A high turnover ratio means lots of buying and selling, and at 210%, the Columbia fund's ratio is plenty high.

That means the fund's trading volume is more than twice the value of the fund; its manager is essentially replacing his entire investment portfolio twice every year. It also means that you might not want to put too much stock in that list of top holdings. It's usually reported quarterly, and by the time you read it, many of the holdings may have already been sold.

And another thing ...
OK, so you're not going to cherry-pick from the fund's holdings. Perhaps you'll just buy into the fund. Well, keep in mind that that high turnover can mean lots of distributed taxable capital gains, and all that trading can be costly, too. Still, if the fund is likely to beat the market handily, it might be worth it.

There are solid funds with lower turnover, though, and very low turnover suggests managers with a lot of conviction in their stock picks. The Columbia Acorn Z (ACRNX) fund, for example, sports a five-year average return of 15%, a low 20% turnover ratio, and recent top holdings of Coach (NYSE: COH), Amphenol (NYSE: APH), and XTO Energy (NYSE: XTO). (Oh, and a minimum investment of $75,000.)