Thursday, January 24, 2013

Why Investors Need To Be Able Measure Portfolio Turnover
                               by: Brendan Magee

Diane told me how happy she was with her current investment advisor. She told me she was happy to have found someone whom she could trust, and I asked what was it about her advisor that she liked so much.

She told me how she had come to know him. Her father had passed away and the manager for the  firm that had been handling her father's investments called her. He let her know that that the broker, whom Diane had never met before, who had been handling her father's account was no longer with the company. The manager told her they had discovered that the broker had been engaging in an excessive amount of trading on behalf of her father's account which was generating a lot of commissions for the broker at the expense of her father's account.

The branch manager told Diane that their firm does not condone their brokers putting their personal gain ahead of their client's and as such that broker's employment with the firm had been terminated. Never mind the fact that the firm's manager didn't let Diane know that the manager had the responsibility of monitoring the behavior of their brokers, she felt good that the manager reached out to her and let her know that he would personally take over the day to day management of the money she was receiving from her father's portfolio. Diane felt that her interests were being looked after. Hence she felt she was in the hands of someone she could trust.

This is where the story takes an ironic and deceitful twist. The advisor said he would transfer the money to one of the frim's mutual funds and that would protect her money from excessive trading. So as we were talking I asked if she could measure the amount of turnover that was taking place in the fund her money was in. She answered no. The follow up question was, could she account for all the costs she was paying for the managemet of her money in the fund and again she answered no.

Now let's first understand what turnover in a fund is. Turnover is a measurment of  the amount of trading that goes on inside a fund. For example if the turnover rate is 100%, that means that within the year every stock within the fund has been sold and replaced with new stocks, and just like the more trading the broker was doing on her father's account, a higher percentage of turnover means the more commissions and other expenses  a mutual fund investor is going to pay.

The fund Diane was investing in had 79 different stocks and a turnover rate of 79%. So more than two thirds of the stocks owned by the fund were being sold and replaced with new stocks. This equates to an added expense of about one percent for the trading the fund was doing. Bear in mind, their is no where in her statements that these trading expenses are accounted for so she has no idea that this is going on.

The hypocrisy on the part of the manager is that he said the firm didn't condone the excess trading being done to her father's account, but then he endorses Diane investing her money in a very actively trading mutual fund that hides the expenses she is absorbing. You also have to understand that Diane has no control over the amount of trading her fund could be doing. It could go up to 200% and she'd have no idea as to what is going on.

The only way she would know about the amount of trading going on in her mutual fund is to ask and be able to answer the question, Can you measure the amount of turnover that is taking place inside your fund? If she realizes that a higher percentage of turnover means a higher rate of trading, which means higher expenses, which also means a higher degree of gambling and speculation taking place within her investments, she will know to stay away from not only the fund, but also the manager of the brokerage firm.

Brendan Magee is the founder and president of Inevitable Wealth Coaching. With questions or comments call 610-446-4322 or e-mail


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