turnover rate impact on return

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omerthegrouch
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turnover rate impact on return

Post by omerthegrouch » Sun Jul 15, 2018 3:08 pm

I am reading the bogleheads guide to investment, they mention in one chapter how the transaction cost associated with funds that have high turnover rate can really eat away at the return. So I have recently have been looking at vanguard small value index fund, has a return around 15 percent with a turnover of around 19 percent. It would be nice to know how the return is practically impacted by that kind of turnover. Is there a resource for that? what's generally your cutoff for turnover percentage over which you dont like to invest?

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oldcomputerguy
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Re: turnover rate impact on return

Post by oldcomputerguy » Sun Jul 15, 2018 4:11 pm

I seem to recall reading somewhere that Mr. Bogle’s rule of thumb is that 100% turnover roughly equals an additional 1% added to the ER.
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Taylor Larimore
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Re: turnover rate impact on return

Post by Taylor Larimore » Sun Jul 15, 2018 5:17 pm

omerthegrouch wrote:
Sun Jul 15, 2018 3:08 pm
I am reading the bogleheads guide to investment, they mention in one chapter how the transaction cost associated with funds that have high turnover rate can really eat away at the return. So I have recently have been looking at vanguard small value index fund, has a return around 15 percent with a turnover of around 19 percent. It would be nice to know how the return is practically impacted by that kind of turnover. Is there a resource for that? what's generally your cutoff for turnover percentage over which you dont like to invest?
omerthegrouch:

Low-turnover is a very important factor when choosing funds. Mr. Bogle estimates that turnover costs are equal to about one-percent of a fund's assets. There is no "cutoff." Every increase in turnover increases the hidden cost of mutual funds.

Low turnover (currently 3.1% for Vanguard Total Stock Market VTSAX) is an important reason for its outperformance (top 5% in category for 15 year after-tax return).

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

omerthegrouch
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Re: turnover rate impact on return

Post by omerthegrouch » Sun Jul 15, 2018 5:20 pm

taylor thanks for the reply

with that knowledge in mind, would you consider the small value index fund VSIIX to be a no-no for the individual investment account? reserve its use for retirement accounts only

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Re: turnover rate impact on return

Post by pkcrafter » Sun Jul 15, 2018 5:41 pm

Here is some information on tax-efficiency. VSIIX is pretty tax efficient. Can you get access to that fund in a taxable account?

https://www.bogleheads.org/wiki/Tax-eff ... _placement

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Taylor Larimore
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Re: turnover rate impact on return

Post by Taylor Larimore » Sun Jul 15, 2018 6:34 pm

omerthegrouch wrote:
Sun Jul 15, 2018 5:20 pm
taylor thanks for the reply

with that knowledge in mind, would you consider the small value index fund VSIIX to be a no-no for the individual investment account? reserve its use for retirement accounts only
omerthegrouch:

Most of us are tempted to add funds that we think will "beat the market." Stocks in the small-value index fund VSIIX are already in Vanguard Total Stock Market Index Fund. I doubt if the additional cost and risk of adding an overlapping fund is worth the additional complexity.

Please read my "Simplicity" link below.

Best wishes.
Taylor
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Dandy
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Re: turnover rate impact on return

Post by Dandy » Sun Jul 15, 2018 7:21 pm

As i recall turnover expenses, which are mainly, commissions are not included in mutual fund expense ratios. Another advantage of most index funds that is not normally discussed.

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Re: turnover rate impact on return

Post by asset_chaos » Sun Jul 15, 2018 8:14 pm

If you're looking at an index fund, the gauge for the effect of any cost is how closely does the fund track its index and has it made taxable capital gains distributions. Vaguard's info page says its small value fund (vsiax, the admiral shares because that's what I use) has over its life (past 7 years) trailed its benchmark by 3 basis points per year and hasn't made cap gains distribution in at least the last couple of years (I don't think it ever has, but can't find the verification for that at the moment). In fact the investor shares are even better: since 1998 Vanguard says they have returned 12 basis points per year more than the benchmark.

I believer the 1% per year turnover cost mentioned above is an estimate for a typical active fund. Because this fund is not trailing its benchmark by 1% or so a year, it's either not incurring those kinds of costs for its turnover, or it's offsetting the costs in other ways (possibly with securities lending). In either case, whatever this fund's turnover is, it's not impacting the fund's ability to closely track its index. For index funds that's what matters.
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omerthegrouch
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Re: turnover rate impact on return

Post by omerthegrouch » Sun Jul 15, 2018 9:06 pm

asset-chaos

i looked at the morning report for vsiix, you are right there are no capital gains over the last year but it does pay out a dividend. i find that confusing if you are paying a dividend, why is not being taxed?

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Re: turnover rate impact on return

Post by livesoft » Sun Jul 15, 2018 9:11 pm

I don't care about turnover of passively-managed low-expense ratio index funds, so I just don't have a cutoff. One can compare an index fund's performance to its benchmark. If the fund's performance is inline with its benchmark, then I don't see a problem with the caveat that the fund should still be as tax efficient as possible.

My personal portfolio made up of passively-managed index funds has a very high turnover, yet is very tax efficient due to location choices and meets or exceeds the performances of its benchmarks. This is my evidence that turnover is a red herring.

Note that I did NOT state that turnover is a red herring when one is writing about actively-managed funds.
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Re: turnover rate impact on return

Post by LadyGeek » Sun Jul 15, 2018 9:29 pm

This thread is now in the Investing - Theory, News & General forum (theory).
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asset_chaos
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Re: turnover rate impact on return

Post by asset_chaos » Mon Jul 16, 2018 1:49 am

omerthegrouch wrote:
Sun Jul 15, 2018 9:06 pm
asset-chaos

i looked at the morning report for vsiix, you are right there are no capital gains over the last year but it does pay out a dividend. i find that confusing if you are paying a dividend, why is not being taxed?
Dividends are taxed, but the question was about the consequences of turnover. Fund turnover is the amount of buying and selling of securities the fund does. Dividends and capital gains distributions are generated by different sources (and have different tax treatments, but let's not get into that here). If a fund holds stocks and the stocks pay dividends, the fund passes that money to the fund shareholders who are taxed on the dividend distribution. Dividends happen without the fund needing to buy or sell any stocks; if the fund has zero turnover, there can still be dividends. On the other hand, if a fund buys a stock for one price and sells it later for a higher price, then the difference in the prices is a realized taxable capital gain. (Of course, a fund can sell stocks for lower prices and realize a capital loss, so it's the net results from all the fund's buying and selling that matters.) Funds are required by law to pass net capital gains to their shareholders who pay the taxes on the capital gain. If a fund has zero turnover, then by definition it doesn't realize capital gains and has no taxable capital gains to pass to its shareholders. Taxable capital gains distributions can come from turnover, but dividends do not.

The Bogleheads wiki (link at the top of every board page) has an entry on capital gains distributions that has additional information.

The point I was trying to make for this thread is that it is possible that an index fund closely adheres to its index by doing a lot of buying and selling, but if that buying and selling generates a lot of capital gains for you the shareholder to pay taxes on, then the reality is that you the fund shareholder will trail the fund results by the amount of capital gains taxes you have to pay. This systematic reduction in your returns doesn't show up on the funds' results because they're almost everywhere reported pre-tax. That's why in order to see the effects of turnover for index funds, you have to check both how closely the fund tracks its index and if it distributes capital gains. For the small value index fund in question, it tracks closely and has not distributed capital gains: it's not giving you some secret 1% haircut every year. However Vanguard manages that index fund, it's doing what it says it will do: you get the return of the index the fund follows. (Whether you should invest in it is just an entirely separate question with many threads offering different opinions.)

This also illustrates one of the differences with active funds, who are active precisely because they do a lot of buying and selling. Most active funds, I believe, distribute capital gains most years: active funds almost always have this systematic reduction of your returns due to capital gains distributions and the taxes they make you pay.
Regards, | | Guy

omerthegrouch
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Re: turnover rate impact on return

Post by omerthegrouch » Mon Jul 16, 2018 8:28 am

asset chaos

in other words if the index fund is tracking its index closely and the buying and selling is done in a way that the capital gain distribution is zero then the turn over is a moot point.

thanks for your detailed reply. Its starting to make more sense now.

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Re: turnover rate impact on return

Post by asset_chaos » Mon Jul 16, 2018 8:43 pm

omerthegrouch wrote:
Mon Jul 16, 2018 8:28 am
asset chaos

in other words if the index fund is tracking its index closely and the buying and selling is done in a way that the capital gain distribution is zero then the turn over is a moot point.

thanks for your detailed reply. Its starting to make more sense now.
Yes, that's what I mean. You're welcome.
Regards, | | Guy

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