A portfolio's turnover rate measures the level of buying and selling of investments. You will typically see a turnover ratio when analyzing mutual and index funds. They are the same thing.
Why It's Important
High turnover rates can lead to higher portfolio expenses. Not only that, but usually, if a portfolio has a high turnover rate or ratio, the more taxes you will potentially have to pay. Once a position is sold out of the portfolio, you will either have a capital gain or a capital loss. A good advisor will attempt to make sure your gains and losses offset so that you will not have additional tax implications. But this is not always possible. Paying attention to the turnover rate is super important to avoid a tax headache later.
If you are investing in a taxable account, it is best to look for tax-advantaged funds or ones with low turnover. Tax-deferred or tax-free accounts (such as IRAs and 401ks) do not matter quite as much since you are not being taxed on the capital gains anyway.
A transaction fee is a fee charged by a brokerage firm for every trade that takes place. These fees can range from $0 to $9.95, depending on the firm.
Why It's Important
Transaction fees are significant because anytime you make a buy or sell trade in your account, you're charged that fee. So, let's say you need to sell out of investments and invest in something different. You will have to pay that fee not once but twice for each investment. Let's say the fee is $4.95 per transaction; you would have to pay $9.90 per investment to sell then subsequently buy a new security. Multiply that by how many investments you are trying to get rid of, and it could be quite expensive. I have seen situations where an investor paid hundreds of dollars just in fees to get out of bad investments!
Transaction fees are becoming a little less important because most of the brokerage firms have moved to $0 fees this year. Among the firms that have made the change are Ally Invest, Charles Schwab, TD Ameritrade, and Fidelity. Of course, Robinhood has always been $0 fees since they started. With that said, there are plenty of options out there, and I don't think anyone needs to be charged a transaction fee unless you choose to go through an institution.
A mutual fund is a pool of managed investments. These funds are usually managed by a portfolio manager to keep them in line with their investment objectives.
Why It's Important
The best way to think of mutual funds is as a basket. When you purchase shares of mutual funds, you are purchasing a basket of different stocks or bonds. I love mutual funds, and that's typically all I invest in.
Mutual fund benefits include professional management, diversification, liquidity, and brokerage commission savings. You are pretty much paying a mutual fund company to create a basket of stocks that meet your investing needs. For instance, you can find mutual funds of marijuana companies, international companies, and even companies that focus on sustainability. There were over 9,600 mutual funds available on the market as of 2018. So, there is plenty to choose from! You save on brokerage commissions because if you were buying individual stocks, it would be way more expensive. Some mutual funds have upwards of 3,000 stocks within them. If you were going to recreate that yourself, you would have to make at least 3,000 trades at whatever the commission rate is for the brokerage firm (currently ranging between free and $10) versus making one trade for the whole basket.
The only downside to mutual funds is that they carry fees. Of course, you would have to pay the company/investment manager for their work, putting the mutual fund together and keeping it updated. My rule of thumb is never to purchase a mutual fund above 60 basis points. To me, anything above that is excessive with so many options available.