There are many types of turnover. In business, there are accounts receivable, inventory, and employee turnover. But there’s also investment turnover.
Knowing the Portfolio’s Turnover Ratio
In investing, the turnover ratio is the percentage of mutual funds or other portfolio holdings that have been replaced yearly.Some portfolio funds are held for less than 12 months. This means their turnover ratios exceed 100 percent. But that doesn’t necessarily mean that all the holdings have been replaced. The ratio reflects the proportion of holdings that change per year.
- portfolio manager’s investment style
- type of mutual fund portfolio
- investment objective
The type of fund, like a stock market index fund, will have a low turnover rate. That’s because it duplicates a particular index. It replaces holding only when there’s a change in the index.
Computing and Reading a Turnover Ratio
Keep in mind that the turnover ratio is an approximate number. Many funds hold onto a large portion of the holdings for many years. Any activity may be focused on a small or moderate percentage of the portfolio.So, you wouldn’t want to state the fund changes all of its positions once every so-and-so years. Instead, a more correct explanation is a certain portion of the assets are traded “frequently.” Most of the other assets are held for several years.
For example, a mutual fund may have $500 million in assets at the start of the year. At the end of the year, it has $600 million in assets. It can be assumed the average assets are $550 million.
The fund managers bought $200 million in securities throughout the year and sold $150 million. In this case, you take the lower of the two values.
The formula for the turnover ratio is: ($150 million/$550 million)*100 = 27.27 percent.
Average Turnover Ratio
Although a fund’s ratio shouldn’t be the sole basis for investing or devesting, it should be noted. It can be helpful to compare the fund you’re interested in with other funds’ turnover ratios.The average turnover ratio for a managed mutual fund is 75–115 percent. If you are a conservative-thinking equity investor, you might want to see a 50 percent turnover ratio.
Is High or Low Investment Turnover Ratio Better?
A high turnover ratio isn’t necessarily bad. The same goes for a low turnover. It’s important, however, to be aware of the consequences of turnover frequency.A low turnover ratio can be beneficial depending on the investor’s goals. This strategy will often improve a client’s odds of long-term solid performance. It’s a buy-them-and-hold-them mentality. Managers who keep the turnover ratio low often practice low-risk strategies. But it could also indicate a passive fund manager.
A high turnover ratio increases the fund’s costs due to the payment of spreads and commissions. These costs could be reflected in the fund’s return. But on the other hand, it does indicate an active, engaged fund manager who is maneuvering to increase the funds’ assets.
Portfolio Turnover and Taxes
Higher portfolio turnover or high ratio may generate short-term capital gains. These are profits on holdings held for less than one year and are taxable. They are taxed at an investor’s ordinary income rate. This is often higher than the capital gains rate.Synopsis of Reading Investment Turnover
Although a turnover ratio alone won’t help you choose the “right” mutual fund, it can tell you the percentage of stocks and other assets replaced yearly.It’s best to look not only at the turnover ratio but the fund’s overall performance. Ensure the fund reflects your investment mentality.
Finally, always consult an investment advisor with questions or concerns.