Investor Toolkit: How to measure the high cost of portfolio turnover

Every Wednesday, we publish our “Investor Toolkit” series on TSI Network. Whether you’re a beginning or experienced investor, these weekly updates are designed to give you specific investment advice. Each Investor Toolkit update gives you a fundamental piece of strategy, such as stock trading advice, and shows you how you can put it into practice right away. Today’s tip: “Portfolio turnover costs money, so make sure that most of your investments are ones you might want to hold on to indefinitely.” Investors often wonder how often they should sell investments they own and buy new ones. Our answer: as rarely as possible. That’s because portfolio turnover cuts into your profit. Every time you buy and sell a stock you face three costs: Brokerage commissions. Every transaction involves brokerage commissions or similar costs, even if these costs are hidden or built into the price you pay or receive. Losses to the bid-ask spread. If you want to carry out a transaction right away, you have to accept the highest available ‘bid’, or pay the lowest ‘offer’. You can enter your own bid or offer. But this means you have to wait for another investor who is willing to do business at your price. Meanwhile, prices could move against you. Taxes. If you sell at a profit in your taxable account (outside your RRSP), you usually have to pay capital gains taxes. [ofie_ad]

Successful investing means portfolio turnover of 25% or less in a year

Here is how you measure your portfolio turnover. First, add up the value of all investments you bought during the year, and all investments you sold. Next, add the beginning and year-end values of your investment portfolio. Divide the first number by the second. Example: You sold shares and exchange-traded funds worth $20,000. You held on to $3,000 to pay capital-gains taxes, and bought shares and ETFs worth $17,000. Total, $37,000. Your portfolio is worth $50,000 at the beginning of the year and $57,000 at year’s end, for a total of $107,000. The next step is to divide $37,000 by $107,000. The result is 34.6%. That means that you replaced an average of 34.6% of your portfolio during the year. That’s on the high side. Many successful investors have portfolio turnover of 25% a year or less. Our investment advice: Cut turnover and raise your profit. It pays to seek out stocks that you might want to hold on to indefinitely. You’ll change your mind on some of them, of course. But you’ll hold others for decades, and these will give you your biggest profits. COMMENTS PLEASE—Share your investment knowledge and opinions with fellow TSINetwork.ca members Do you tend to buy and hold stocks for a long period of time? Or do you keep some stocks for a shorter period and sell them after a price surge, or a fall in price? Do the costs of trading figure into your decision as to whether to buy, sell or hold a stock? Let us know what you think.