The Cost of Churning

Why good investing sometimes requires the discipline to do nothing

There is a question many investors quietly ask when their portfolio has not changed for several months: “What exactly is my advisor doing?”

It is an understandable question. We naturally associate activity with work. A new investment, a portfolio switch, a change in allocation or a new recommendation is visible. It gives us something tangible to point to. But investing is different.

If a portfolio was constructed after understanding the investor’s goals, time horizon, risk profile, risk capacity and financial circumstances, and the investments were selected after appropriate research, the absence of change does not necessarily mean the absence of advice. Sometimes, it simply means the original decision is still working as intended.

Consider how a doctor approaches treatment. A doctor does not change the medicine every day simply because the patient’s condition has not visibly changed. A treatment is prescribed for a reason, monitored over time and reviewed against the expected outcome. If the response is appropriate, the treatment continues. If the evidence suggests something needs to change, the treatment changes.

Investing requires a similar discipline. A decision does not become a bad decision simply because it has not been changed recently. And that is where the cost of churning begins.

The Pressure to “Do Something”

The problem is particularly visible in financial markets because prices and performance are constantly available. Investors can see what their investments did yesterday, last month and over the last year. They can compare one fund with another, one stock with another and one strategy with another. This creates an endless stream of reasons to question an existing decision.

A fund has underperformed for six months. Another fund has delivered 20%. A stock has fallen. A different asset class is doing well. A new product has entered the market. The temptation is to respond.

But market information is not the same as a decision trigger.

An investment can experience temporary underperformance while remaining consistent with the original thesis. A strategy can move through a period of unfavourable market conditions. An asset can decline while still serving an important role in the overall portfolio.

The question, therefore, should not be “What can we change?” It should be “Has anything changed that requires us to change?” That is a very different approach to portfolio management.

The Cost of Unnecessary Change

Churning is not simply about making too many transactions. It is about changing investments without a sufficiently strong reason. And unnecessary change can create costs at several levels.

Financial Cost

Selling an appreciated investment can create a tax liability. The tax paid leaves the portfolio and is no longer available to compound. There may also be exit loads or other transaction-related costs, depending on the investment.

This creates a simple but important principle: every time capital is unnecessarily taken out of the compounding cycle, future wealth creation is affected.

Tax should never prevent a necessary portfolio change. But if the underlying investment remains appropriate, repeatedly realising gains and paying taxes simply to move from one investment to another can create avoidable leakage. The cost may look small at each individual transaction, but over a long investment horizon it can become meaningful.

Portfolio Cost

An investment should never be evaluated entirely in isolation. Every holding interacts with the rest of the portfolio. Replacing one investment may increase concentration, introduce additional overlap, alter the portfolio’s risk characteristics or move the overall asset allocation away from its intended structure.

A new investment may look better on its own and still make the portfolio worse. This is why the right question is not “Is the new investment better?” but “Does replacing the existing investment improve the portfolio?”

Behavioural Cost

This is often the most underestimated cost. Frequent changes can create a cycle:

Underperformance → discomfort → switching → chasing recent performance → disappointment → another switch.

The investor becomes increasingly focused on what has happened recently rather than why the investment was selected in the first place. Over time, this can turn a long-term investment strategy into a series of short-term reactions. The portfolio becomes more active, but the investor may actually become less disciplined.

When Should an Investment Actually Be Changed?

The argument against unnecessary churn should not be confused with “buy and forget.” Investments need to be reviewed. But reviewing an investment and changing an investment are two different decisions.

A change may be appropriate when something material has changed:

1. The investment thesis has changed. The original reason for selecting the investment is no longer valid.
2. There is sustained deterioration in management or investment process. A meaningful and persistent deterioration has occurred in how the investment is managed.
3. There is material style drift. The investment has moved significantly away from the role, mandate or strategy for which it was selected.
4. There is excessive concentration or overlap. The investment, together with other holdings, has created unintended concentration or duplication of risk.
5. Financial goals or time horizon have changed. An investment appropriate for a long-term objective may need reconsideration as the goal approaches.
6. Risk profile or risk capacity has changed. An investor’s willingness to take risk may change, as can the ability to absorb losses because of changes in income, liabilities, dependants, liquidity or financial circumstances.
7. Asset allocation requires rebalancing. If the portfolio has moved materially away from its intended allocation, bringing it back towards the target is disciplined portfolio management rather than churning.
8. Tax considerations justify restructuring. There may be situations where restructuring improves the overall tax efficiency of the portfolio.
9. The portfolio can be constructed more effectively. A change may make sense because the overall portfolio can be improved, even though the existing investment itself has not become “bad.”
10. Regulatory or product changes require action. A material change in the product, mandate or regulatory environment may require the investment strategy to evolve.

These are genuine reasons to reconsider an investment. Recent performance alone is not necessarily one of them.

Give Good Decisions Time to Work

This is perhaps the most important discipline in long-term investing. When an investment is selected, there is an implicit expectation about what it is meant to achieve and over what period. That expectation cannot be evaluated meaningfully every few weeks. A good decision needs time.

This does not mean ignoring performance. It means putting performance into context. Is the underperformance temporary or structural? Is the investment still following its intended process? Has the underlying risk changed? Has the investor’s situation changed? Is the portfolio still aligned with the original objective?

If the answers remain satisfactory, staying invested may be the most rational decision. Time is not the absence of portfolio management. Time is an essential part of portfolio management.

The Advisor’s Activity Is Not the Measure of Advice

There is an important lesson here for advisors as well. Clients naturally want to see activity. If an advisor regularly changes investments, it can create a perception that the portfolio is being actively managed. But the number of transactions is not a measure of advisory quality.

An advisor may spend considerable time reviewing performance, investment processes, portfolio exposures, asset allocation, taxation and the client’s circumstances and arrive at a very simple conclusion: “Nothing material has changed. Stay invested.”

That is still advice. In fact, it may be the result of a more disciplined process than constantly finding something new to buy.

The objective of an advisor should not be to maximise activity. It should be to maximise the quality of decisions that matter.

The Discipline to Do Nothing

There is a subtle but important difference between doing nothing and choosing not to act. Doing nothing can be neglect. Choosing not to act after reviewing the evidence is a decision. The distinction lies in the process behind it.

If an investment was selected for a reason, fits the investor’s goals and risk profile, remains appropriate within the portfolio, and nothing material has changed, then changing it merely to demonstrate activity can be counterproductive.

The next time you or your advisor feels the urge to make a change, ask one simple question:
“What has actually changed?”

If the answer is nothing material, perhaps the right action is not another transaction. Perhaps it is patience.

Because good investing is not about constantly doing something. Sometimes, the best advice is to do nothing.

Harendra Zatakia CFP

Harendra is a SEBI-Registered Investment Adviser, CFP professional, and Founder of Wealth Aligned Financial Advisory, with over two decades of experience in global investment banking, including senior leadership roles at Nomura, Citi, and UBS.