A 100 percent turnover rate means the average stock in the fund portfolio is held for one year before selling, Slome says. If the turnover rate is 25 percent, stocks are held an average of four years.
"Some funds will have 300 percent to 400 percent turnover, so they only hold stocks for three or four months," Slome says. "At the end of the year, investors are surprised when they get this big fat tax bill." This can happen even when the market is down for the year.
Another tax-related issue to consider is the fund's capital gain distribution schedule. If you receive a capital gain following the purchase of a fund, you will incur a tax, even if you didn't own the shares at the time the gain was realized.
"Some mutual funds will (distribute capital gains) as early as October," Place says. "I've seen in the past where people have purchased a fund and had a little bit of a surprise."
Even in tax-deferred accounts, turnover is an issue because the fund incurs transaction costs, and while fund investors don't pay it directly, they pay for it with lower returns. In his book "The Little Book of Common Sense Investing," John Bogle, founder of The Vanguard Group and proponent of low-turnover index funds, estimates that "turnover costs are roughly 0.5 percent on each purchase and sale, meaning that a fund with 100 percent portfolio turnover would carry a cost to shareholders of about 1 percent of assets, year after year."
In short, high turnover funds can cost investors a lot of money over time.
Read letter to shareholders
Once you invest in a mutual fund, you'll start receiving annual, and perhaps semiannual, editions of another chunky document: the shareholder report. The good news is that it's perfectly OK to skip a lot of what's in these reports.
Slome says the letter to shareholders in the annual report provides a general assessment that's like a view from 10,000 feet. "It will tell you what's worked in the economy, what hasn't worked, what's impacted the performance of the fund," he says. "It will usually talk about the macro-economic environment."
Saulnier and Mecca agree that the letter is a good place to start, and they don't see much point in going any further. Apart from the letter, Saulnier says, the annual report is filled mainly with "financial gobbledygook."
And Mecca adds: "I don't put a lot of credence in the annual report. By the time it's printed and sent out, things change. Annual reports, in my opinion, are just marketing pieces to show at any one particular time what the asset allocation was, and specific details of where the investments were made."
Once you learn to separate the fiber from the fluff in a mutual fund report, you can do more than just build your biceps when you pick up one of the colossal documents. You can actually get from it what you need to know to create a healthy investment plan.