of its port- folio in a year; that is, after six months it has replaced about half of its portfolio. Funds with low turnover generate fewer taxes each year. Consider the nations top two largest mutual funds, Fidelity Magellan and Vanguard Index Trust 500 Portfo- lio. The Vanguard fund, with an extremely low turnover rate of 5%, handed its investors less of an annual tax bill the past three years than Magellan, which had a turnover rate of 155%. Diversified U.S. stock funds on average have a turnover rate of close to 90%. Vanguard Index Trust 500 Portfolio, at $42 billion the second-largest fund in the country, has low turnover, and as an index fund youd expect it to stay that way. Index funds buy and hold a basket of stocks to try to match the performance of a market benchmark-in this case, the Standard & Poors 500 Index. But turnover isnt a constant. Though Fidelity Magel- lan, at $58 billion the largest fund in the nation, shows a high turnover rate of 155%, thats because its new man- ager Robert Stansky has been revamping the fund since he took over from Jeffrey Vinik last year. The turnover rate could well go down, along with Magellans taxable distributions, as Mr. Stansky settles in. It makes sense that turnover would offer clues about how much tax a fund would generate. Funds that just buy and hold stocks, such as index funds, arent selling stocks that generate gains. So an investor has to pay taxes only when he sells the low-turnover fund, if the fund has appreciated in value. On the other hand, a fund that trades in a frenzy could generate lots of short-term gains. For instance, a fund sells XYZ Corp. after three months, realizing a gain of $1 million. Then it buys ABC Corp., and sells it after two months, realizing a gain of, say, $2 million. By law, these gains have to be distributed to investors, who then have to pay taxes on them, and since theyre short-term gains, the tax rate is higher. Fans of low-turnover funds say that, in general, such portfolios have had higher total returns than high- turnover funds. There are always exceptions, of course: Peter Lynch, former skipper of giant Fidelity Magellan fund, racked up huge returns while trading stocks like they were baseball cards. Still, one reason low-turnover funds might have higher returns is that they dont incur the hidden costs of trading, such as commissions paid to brokers, that can drain away a funds returns.   Source: Robert McGough, "Low Turnovers May Taste Very Good to Fund Owners in Wake of Tax Deal," The Wall Street Journal, July 31, 1997, p. C1. Reprinted by permission of The Wall Street Journal, 1997 Dow Jones & Company, Inc. All Rights Reserved Worldwide.             CONCEPT C H E C K ☞ QUESTION 3 An investors portfolio currently is worth $1 million. During the year, the investor sells 1,000 shares of Microsoft at a price of $80 per share and 2,000 shares of Ford at a price of $40 per share. The proceeds are used to buy 1,600 shares of IBM at $100 per