David John MarottaDavid John Marotta is the President of Marotta Wealth Management, a fee-only financial planning and asset management firm in Charlottesville, Virginia. He is an oft-quoted writer and speaker on financial matters and his weekly financial column can be found at www.eMarotta.com
Host: What else should I look for in mutual fund selection?
David Morotta: In addition to no loads and low expense ratios, you should also look for funds that have low turnover ratios. The turnover ratio is what percent of the investments are bought or sold every year. So, a turnover ratio of 50% means that every year half of the investments are bought and a different investments are sold.
Another way to look at it is, a turnover ratio of 50% means that every two years, the entire portfolio is turning over and your time horizon when you buy an investment is only two years. Your investments are only being held for two years. A turnover ratio of 50% is relatively high, we like to have more of a buy and hold a strategy. So, if you have a buy and hold strategy than the turnover ratio may go down to as low as 5% or 10%.
So, we recommend mutual funds with a turnover ratio of over 50% or avoid it entirely less than 5% or 10% turnover ratio is very good.