What Is Portfolio Turnover?
Portfolio turnover is a measure of how frequently assets within a fund are bought and sold by the managers. Portfolio turnover is calculated by taking either the total amount of new securities purchased or the number of securities sold (whichever is less) over a particular period, divided by the total net asset value (NAV) of the fund. The measurement is usually reported for a 12-month time period.
Key Takeaways
- Portfolio turnover is a measure of how quickly securities in a fund are either bought or sold by the fund's managers, over a given period of time.
- The rate of turnover is important for potential investors to consider, as funds that have a high rate will also have higher fees to reflect the turnover costs.
- Funds that have a high rate usually incur capital gains taxes, which are then distributed to investors, who may have to pay taxes on those capital gains.
- Growth mutual funds and any mutual funds that are actively managed tend to have a higher turnover rate than passive funds.
- There are some scenarios in which the higher turnover rate translates to higher returns overall, thus mitigating the impact of the additional fees.
Understanding Portfolio Turnover
The portfolio turnover measurement should be considered by an investor before deciding to purchase a given mutual fund or similar financial instrument. That's because a fund with a high turnover rate will incur more transaction costs than a fund with a lower rate. Unless the superior asset selection renders benefits that offset the added transaction costs, a less active trading posture may generate higher fund returns.
In addition, cost-conscious fund investors should take note that the transactional brokerage fee costs are not included in the calculation of a fund's operating expense ratio and thus represent what can be, in high-turnover portfolios, a significant additional expense that reduces investment return.
100%
The turnover rate a very actively managed fund might generate, reflecting the fact that the fund's holdings are 100% different from what they were a year ago.
Managed Funds vs. Unmanaged Funds
The debate continues between advocates of unmanaged funds such as index funds and managed funds. S&P Dow Jones Indices, which publishes regular research on how actively managed funds perform compared to the S&P 500 index, claims that 75% of large-cap active funds underperformed the S&P 500 in the five years leading up to Dec. 31, 2020.
Meanwhile, in 2015, a separate Morningstar study concluded that index funds outperformed large-company growth funds about 68% of the time in the 10-year period ending Dec. 31, 2014.
Unmanaged funds traditionally have low portfolio turnover. Funds such as the Vanguard 500 Index fund mirror the holdings of the , whose components infrequently are removed. The fund registered a portfolio turnover rate of 4% in 2020, 2019, and 2018, with minimal trading and transaction fees helping to keep expense ratios low.
Some investors avoid high-cost funds at all costs. By doing so, there exists the possibility that they may miss out on superior returns. Not all active funds are the same and a handful of fund houses and managers actually make a habit out of consistently beating their benchmarks after accounting for fees.
Often, the most successful active fund managers are those who keep costs down by making few tweaks to their portfolio and simply buying and holding. However, there have also been a few cases where aggressive managers have made regularly chopping and changing pay off.
Portfolio turnover is determined by taking what the fund has sold or bought—whichever number is less—and dividing it by the fund's average monthly assets for the year.
Taxes and Turnover
Portfolios that turn over at high rates generate large capital gains distributions. Investors focused on after-tax returns may be adversely affected by taxes levied against realized gains.
Consider an investor that continually pays an annual tax rate of 30% on distributions made from a mutual fund earning 10% per year. The individual is foregoing investment dollars that could be retained from participation in low transactional funds with a low turnover rate. An investor in an unmanaged fund that sees an identical 10% annual return does so largely from unrealized appreciation.
Index funds should not have a turnover rate higher than 20% to 30% since securities should only be added or removed from the fund when the underlying index makes a change in its holdings; a rate higher than 30% suggests the fund is poorly managed.
Example of Portfolio Turnover
If a portfolio begins one year at $10,000 and ends the year at $12,000, determine the average monthly assets by adding the two together and dividing by two to get $11,000. Next, assume the various purchases totaled $1,000 and the various sales totaled $500. Finally, divide the smaller amount—buys or sales—by the average amount of the portfolio.
For this example, the sales represent a smaller amount. Therefore, divide the $500 sales amount by $11,000 to get the portfolio turnover. In this case, the portfolio turnover is 4.54%.
FAQs
Portfolio turnover is calculated by taking either the total amount of new securities purchased or the number of securities sold (whichever is less) over a particular period, divided by the total net asset value (NAV) of the fund. The measurement is usually reported for a 12-month time period.
How is portfolio turnover calculated? ›
Portfolio turnover is calculated by taking the lower of the total of new stocks purchased or sold over 12 months, divided by the fund's average assets under management (AUM).
Is portfolio turnover good or bad? ›
Generally speaking, a low turnover ratio is desirable over a high turnover ratio. The rationale is that there are transaction costs involved with making trades (buying and selling securities). In addition, funds with a higher portfolio turnover ratio are more likely to incur higher capital gains taxes.
What is the formula for turnover? ›
To determine your rate of turnover, divide the total number of separations that occurred during the given period of time by the average number of employees. Multiply that number by 100 to represent the value as a percentage.
How do you calculate investment turnover in accounting? ›
The turnover ratio measures fund yearly trading activity. It is calculated by taking the lesser of purchases or sales, dividing that number by average monthly net assets.
How does portfolio turnover affect taxes? ›
The rate of turnover is important for potential investors to consider, as funds that have a high rate will also have higher fees to reflect the turnover costs. Funds that have a high rate usually incur capital gains taxes, which are then distributed to investors, who may have to pay taxes on those capital gains.
What does portfolio turnover tell you? ›
In mutual funds, the portfolio turnover ratio measures the rate at which a fund's securities are bought and sold within a year. Aggressively managed funds tend to have higher turnover rates as compared to conservative funds. High turnover rates can lead to increased expenses in terms of fund management.
Is 5% turnover good? ›
There's no good or bad turnover rate. Some industries have high turnover rates by their nature. Information technology has a high turnover ratio because its employees are in high demand elsewhere.
Is 20% turnover bad? ›
This means you have a bad work environment or are paying under market value. If your bad turnover rate is more than 15 percent per year, you should take a close look at your compensation and company culture.
Is 10% turnover bad? ›
Turnover rates vary significantly from industry to industry. However, turnover rates should (ideally) be lower than 10%, which is a very healthy turnover rate across the board.
Monitoring turnover is an important function of human resources. Companies want to monitor the movement of employees out of the organization so they can look for and minimize causes of turnover. Controlling turnover is one of the many quantitative ways the HR department can affect the bottom line.
Is turnover the same as revenue? ›
Revenue refers to the money companies earn by selling products or services for a price, whereas turnover is the number of times companies make or burn through assets. In reality, turnover affects the efficiency of companies, while revenue affects profitability.
What is turnover vs profit? ›
Profit refers to a company's total revenues minus its expenses. Turnover is how quickly a company has sold its inventory, collected payments compared with sales, or replaced assets over a specific period. Generally speaking, turnover looks at the speed and efficiency of a company's operations.
What is a good turnover ratio? ›
For most industries, the ideal inventory turnover ratio will be between 5 and 10, meaning the company will sell and restock inventory roughly every one to two months. For industries with perishable goods, such as florists and grocers, the ideal ratio will be higher to prevent inventory losses to spoilage.
What is an ideal asset turnover ratio? ›
What is a Good Asset Turnover Ratio? A good asset turnover ratio is when it is above 1, since it implies that the company is fully utilising its owned resources to generate sales revenue. The higher the ratio, the better. It means that the company is earning more revenue by using its resources best.
Is higher or lower asset turnover better? ›
Is It Better to Have a High or Low Asset Turnover? Generally, a higher ratio is favored because it implies that the company is efficient in generating sales or revenues from its asset base. A lower ratio indicates that a company is not using its assets efficiently and may have internal problems.
Should portfolio turnover ratio be high or low? ›
For passive mutual fund investments, a turnover ratio near zero is appropriate. If you are investing in a more actively managed fund with the stated goal of generating an aggressive rate of return, the fund could have a higher turnover ratio.
Is high or low turnover better? ›
A fund with a higher turnover ratio purchases and sells more stocks, bonds, and other financial instruments during a given period than a fund with a lower turnover ratio. More transactions mean more fees.
Is high turnover rate good or bad? ›
A high turnover rate negatively affects the company's image. If employees leave due to poor compensation or lack of growth opportunities, it tells potential talent that it is not the best working environment. The image of a satisfied worker is a good way to attract and retain talent.
What is considered high portfolio turnover? ›
A low turnover figure (20% to 30%) would indicate a buy-and-hold strategy. High turnover (more than 100%) would indicate an investment strategy involving considerable buying and selling of securities.
