For tax-paying shareholders of a mutual fund or other invesment portfolio, this term matters a lot. When you turn a portfolio over, it means that you are buying and selling securities...and presumably realizing taxable gains. So if in a given portfolio you have 100% turnover, it means that you likely have zero long-term gains, or will have traded it such that all of your gains have been realized. And taxed.
If you live in a blue state, and you hold shares of a mutal fund that had 100% portfolio turnover, and that fund was up, say, 12% this year, then after taxes, where you pay almost 50% ordinary income tax, and since all of the gains are short-term and paying ordinary income tax, that gain of 12% is just 6%. And that totally sucks in a market that was up 10% overall.
The high portfolio turnover (encouraged by brokers who take their 3-cents-a-share commission happily) destroyed your net after-tax returns.
Warren Buffett's style is pretty much the opposite. He has something like 2% portfolio turnover, as he buys things and holds them "forever" so that he never pays taxes in realizing any gains, and the stocks just sit there boringly and grow and grow and grow. And that's nice. (For his investors.)
Related or Semi-related Video
Finance: What is Modern Portfolio Theory...4 Views
Finance allah shmoop what is modern portfolio theory All right
basic idea Here people Diversification is good Dig it right
C d i g there that's modern Alright let's goto
a gn modern like when hunk and invested from their
cave Well they just invested in good rocks or spears
and really didn't worry about much else And well math
hadn't really been invented yet So like who knew that
If all right well then along came harry markowitz in
nineteen fifty two who tried to science and math the
crap out of the stock market What he came up
with was modern portfolio theory which basically said that there
was a smarter way to invest than just you know
putting your life savings into blockbuster because you like the
logo using all sorts of advanced metrics that we won't
torture you with here The theory he devised was that
well rather than throwing your money against the wall to
see what sticks you could use extensive elaborate data to
determine the best way to maximize your returns depending on
how much risk you were willing Teo you know risk
And there are five key ideas behind modern portfolio theory
And yes of course we have videos on each of
these The first is alfa which is kind of like
how smart you are in the market Then there's beta
which is about volatility in a broadway The vics we
got a whole video set on that Then they're standard
deviation and no that's not some kinky reference to fifty
shades It's more about how the market diverges from your
given individual stock pick and volatile things are finally the
beta then there's our squared it's all about how a
stock or a given index conforms to a given line
or expected return ratio Like how close it is how
proximate is And then finally you have the sharpe ratio
Thank you bill sharp from stanford university who also talked
about being smart in the market so that you could
evaluate your rich turns whether they were smart or just
a lottery ticket Lucky Oh and we're probably not such
a wise investment in the beginning even though they turned
out okay That would be sort of the sharpe ratio
Yeah all right Well in general mpt skews toward less
risky investments but it all comes down to risk reward
Tolerance in the end if for whatever reason you feel
supremely confident that radio shack is about to make a
massive come back well you might be able to justify
taking more risk in loading the dice But to be
clear radio shack was just a bad example So kids 00:02:33.29 --> [endTime] don't try this at home
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