Two mantras of Vanguard's John Bogle are costs matter and turnover matters. We've looked at the former in Can you afford to invest in mutual funds?.
To get a better appreciation of how much turnover matters, Morningstar "Fund Spy" Peter Di Teresa looked at the relationship between turnover and the returns of US-based US equity funds. He found that the average equity fund had an annual turnover of an astounding 87%. That means the fund manager replaced 87% of the fund's assets with new stocks each and every year.
Then he looked at the 5-year compounded annual return of funds with turnovers at least twice the average, less than half the average and less than one-quarter of the average. Here are his results.
Note the roughly 2½% per year difference in returns. You bet turnover matters!
From The Indexer's Secret 17Jun99