Investor Toolkit: An easy way to make higher profits in your stock portfolio

Every Wednesday, we publish our “Investor Toolkit” series on TSI Network. Whether you’re a new or experienced investor, these weekly updates are designed to give you specific advice on the fundamentals of successful investing. Each Investor Toolkit update gives you a fundamental tip and shows you how you can put it into practice right away.

Today’s tip: “Stock portfolio turnover costs money, so buy investments that you might want to hold on to indefinitely.”

Investors often wonder how often they should sell investments they own and buy new ones. The answer: As rarely as possible. That’s because turnover in your stock portfolio cuts into your profits.

Costs of stock portfolio turnover:

• Brokerage commissions: Every transaction you make in your stock portfolio 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 or tax-free savings account), you usually have to pay capital gains taxes.

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• How to measure stock portfolio turnover: First, add up the value of all the investments you bought during the year and all the 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 $20,000 of investments in 2009. You held on to $3,000 to pay capital-gains taxes, and bought $17,000 of investments. That’s a total of $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.

  Stock portfolio turnover: $37,000 divided by $107,000, or 34.6%. You replaced an average of 34.6% of your portfolio in 2009. That’s on the high side. Many successful investors have portfolio turnover of 25% or less a year.

• Cut turnover, raise 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 stocks will give you your biggest profits.

Next Wednesday, July 14, 2010, Investor Toolkit will look at some simple strategies for evaluating a penny stock.

You can get our full analysis, including clear buy/sell/hold advice, on 20 companies in the fast-moving U.S. market in the latest Wall Street Stock Forecaster. What’s more, you can get this issue absolutely free when you subscribe today. Click here to learn how.