Misleading Claims About Mutual Fund Turnover

Late November I mentioned that fool.com claims:

"Index fund turnover is around 5% or lower."

as well as:

"A managed mutual fund has an average turnover rate of approximately 85%..."

The statements are simply not true. I like the Motley Fool web site and have read many great articles there so I am surprised to find such inaccurate and misleading statements in the section of their site they are calling "Investing Basics."

I mentioned that the index fund claim struck me as odd because so many of the index funds I track have much higher turnover. A faithful WylieMoney reader let me know that morningstar tracks 706 index funds. Of those, 149 have a turnover ratio of 5% or lower.

So the claim 21% of index funds have turnover of 5% or lower as of the end of 2007 would be truthful. But the claim that "Index fund turnover is around 5% or lower" is just not true.

I imagine it is possible that at one time the average turnover for all Index funds could have been 5%. Perhaps more index funds track indexes which change more often now. Who knows?

The claim "A managed mutual fund has an average turnover rate of approximately 85%..." also does not ring true, but I can see where this may simply be bad grammar. As one who is not grammatically gifted, I have a little more sympathy here, but if what they are trying to say is: "The average turnover of all Managed Mutual funds is approximately 85%", then they should say that. They may also want to mention that general claims like this aren't worth much.

The reason this bothers me is that general claims about fund categories confuse people and create stereotypes that lead to bad decisions.

If you think that you can pick an index fund and will end up with turnover lower than a managed fund in the same category because of statements like these, you are making a big mistake. It is true that if you randomly pick funds from each type, you are more likely to come out with lower turnover from an index fund, but if you are picking funds randomly, you're not being smart.

Take VISGX Vanguard Small Cap Growth Index fund which has a turnover of 40%.
Compare that to BGRFX Baron Growth a managed small growth fund with 21% turnover.

Bottom line is, with Mutual Funds or anything else in life, general claims aren't very useful for informing specific decisions. If turnover is a factor in your choice of a fund (and it should be, even in tax deferred accounts) research the turnover whether it is an index, managed, or quant fund. Also, take everything you read on the interwebs with a grain of salt (this site included!).

I emailed fool.com about this. I hope they either change the wording or explain why I am wrong!

1 comment:

Tantese said...

Good work. Let us know what you hear.