Portfolio Turnover, What It Is and Why It Matters

I learned a harsh lesson about portfolio turnover during a recession. I was forced to pay capital gains taxes on distributions of a long-term mutual fund holding, even though I didn’t sell any fund shares and even though the fund value had dropped more than 20% that year.

This experience taught me about portfolio turnover and related expenses, including taxes (along with the generally wise and tax-efficient approach of purchasing mutual funds for tax-advantaged accounts, not taxable ones). Since then, I have paid more attention to this notion, not in fear of turnover but recognition of its potential costs and benefits.

So, what is portfolio turnover and why does turnover matter?

Capital Gains Taxes: 5 Basic Things to Know

Selling a stock at a gain may be cause for celebration. But depending on my income level in a certain year and the type of account in which I held the investment, I may owe as little as 0% or as much as 20% of my profit in federal income taxes.

In general, I should focus on finding the best stocks for my portfolio and ignore the tax consequences of buying, selling, and holding investments until its time to file my taxes.

But taxes, like investment fees, can erode my investment growth and detract from my net worth. So I should consider what sorts of taxes apply to my investments (if any) so I can devise and implement a tax-efficient investment strategy.

Roth IRA Rules and How They May Benefit Investors

The Roth IRA has rules that benefit investors of all ages.

If you’re young and need extra cash, you may be able to extract Roth IRA contributions (tax- and penalty-free) to pay for a new house, car, or bicycle; if you’re retirement age, you may be able to withdraw money without paying taxes. Plus, there are beneficial rules for those who are between starting out and spending down assets.

Investing and Taxes: Capital Gains and Dividends

When I started investing, I was concerned about picking the right stocks, mutual funds, and ETFs; matching any financial goals with the right asset allocation; and holding down investment fees. Those issues are important. But I also have learned not to overlook the impact of taxes on investment returns. That said, I can’t be so concerned about taxes that I’m paralyzed from making an investment move. But it helps to consider how investment decisions impact tax liability, both in the present and for the future.