---
title: "How Does Portfolio Churning Affect Your Returns?"
description: "What is portfolio churning? How is churning defined in finance? How turnover in your investment portfolio affects your returns."
canonical_url: https://trendshare.org/how-to-invest/how-does-portfolio-churning-affect-your-returns
markdown_url: https://trendshare.org/ai/how-does-portfolio-churning-affect-your-returns.md
published: 2014-12-01
last_updated: 2017-06-12
content_license: https://trendshare.org/about/disclaimer
---
# How Does Portfolio Churning Affect Your Returns?

Source: https://trendshare.org/how-to-invest/how-does-portfolio-churning-affect-your-returns
Updated: 2017-06-12
Not all stocks are winners. It's a sad truth. Some stocks are big winners in
a shorter period of time than you expect. While [value investing](https://trendshare.org/how-to-invest/what-is-value-investing) intends to reduce the amount
of daily or weekly oversight you exercise over your portfolio, you still need
to pay attention to what's going in with your stocks.

Infrequent and careful [portfolio rebalancing](https://trendshare.org/how-to-invest/what-is-portfolio-rebalancing) can improve your potential returns and minimize your investment
portfolio risk. If done too often—done without care—it can be stock
churning, which can cost you money in real dollars now and thousands of dollars
later.

## What is Portfolio Churning?

What is churning? Simply put, it's the rate of turnover of your
investments.

As you know, [many portfolio managers and stock brokers make money by executing trades for you](https://trendshare.org/how-to-invest/broker-fees). The more trades they make, the more
they make in commissions. The Securities and Exchange Commission regulates
these activities. Per the SEC's definition, *illegal portfolio churning*
is [excessive buying and selling of client investments in order to generate commissions](https://www.sec.gov/fast-answers/answerschurninghtm.html).

That may not apply to you. (If it *does*, contact the SEC to file a
formal complaint.) If you're reading this, you're probably interested in
managing your own stocks—and you're less exposed to that risk!

While the SEC's definition of churn is very specific for legal oversight of
positions with the professional duty to manage money for other people, the
concept itself is a useful measurement for how often your investment positions
change. Like other measurements and metrics, maximizing or minimizing churning
on its own isn't the goal; the goal is still to provide a good return at an
acceptable level of safety with modest effort.

## Portfolio Turnover Ratio

Some analysts review mutual funds by how much value (in money) changes
positions (securities held) in a given year. This *portfolio turnover
ratio* divides either the total sales or purchase transactions in a year by
the average net assets of the fund. If you have a million dollars in a mutual
fund and the manager performed $500,000 in sales for the calendar year, your
ratio is 50. If all of the dollars in the fund changed stock positions in the
year, your ratio is 100.

You may also hear this called the *stock market turnover
ratio*—same definition!

There's no single correct ratio. There's no single acceptable churn rate.
The amount of turnover depends on the volatility of the market as a whole
(volatile markets often present more opportunities to buy and sell), the
investment goals of the fund or the portfolio (short term versus long term),
and even the success of the investment manager. That latter point is subtle.
Just because a million dollar portfolio had a million dollars in sales in one
calendar year doesn't mean that every position was bought or sold during that
year. It could be that a handful of $100,000 investments were modest short-term
successes and added up to that million dollars of sales.

## The Downsides of Portfolio Churn

The immediate effects of portfolio churn are easy to understand. If every
trade costs you money in commissions, minimizing unnecessary trades will save
you money. Likewise, if every trade may incur taxation (especially short-term
capital gains taxes), minimizing unnecessary trades will reduce the money you
pay in taxes. Every tax or commission you pay cuts into the profit you make and
the money you can reinvest to work harder for you in the future.

Those aren't reasons to avoid trading altogether, though the advice of
Warren Buffett and John Bogle to novice investors applies: [Buy the S&P 500 index fund](https://trendshare.org/how-to-invest/buy-the-s&p-index-fund), hold it
forever, and sleep soundly at night. These are reasons to minimize
*unnecessary* churn. By all means, make sensible trades. Buy undervalued
stocks. Sell stocks that won't perform or which have given you the profit you
expect and which won't give you that profit in the future. Sell stocks in favor
of better opportunities.

## Short-Term Thinking and Investment Churn

The worst part of high portfolio churn is the underlying philosophy. It's
easy to fall into the trap of thinking in terms of months and quarters, not
years and decades. This is a pernicious problem for fund managers, who get
evaluated on a quarterly and yearly basis. (Some—not much—pity to
them, as they have to placate multiple clients with widely varying investment
goals.) You know exactly what your goals are and can craft a strategy for
yourself.

If you have the pressure to deliver consistent 3-5% growth, quarter after
quarter (beating the market handily every year, after taxes, fees, and
inflation), you don't have the luxury of buying an undervalued stock and
waiting for it to take off. That might take *years*, and you'll get [pressure starting in December](https://trendshare.org/how-to-invest/should-you-sell-stocks-in-december).

If every mutual fund manager behaved this way and judged the performance of
individual stocks on quarterly results, that's billions of dollars. That's a
lot of stock prices affected by buying and selling. If the corporate officers
and boards of those companies have their own bonuses affected by stock prices,
wouldn't they start to make short term decisions on their own?

A little unnecessary buying and selling of your own stocks isn't responsible
for risk in the global economy. Yet this extra volatility *does* give
value investors like us (small in comparison to the big fish) extra
opportunities to buy good stocks at great prices, hold them while they make
sense, and build real wealth over the long term.

Buy and sell when it's appropriate. Avoid unnecessary transactions. Take the
long view. Don't let the quest for the perfect keep you from reasonable and
even great returns now. Resist the temptation of short-term thinking.  Your
portfolio will thank you for it.