Fund I-Q No. 5: Portfolio Turnover Ratio
  1. Portfolio Turnover
  2. Fund I-Q No. 5: Portfolio Turnover Ratio
  3. Scoring Fund Turnover Data

Fund I-Q No. 5: Portfolio Turnover Ratio

By Richard Loth (Contact | Biography)

Why should fund investors be concerned about portfolio turnover? There are four major reasons, and they all impact a fund's investment quality:

  1. There is an abundance of research that shows that buy-and-hold fund managers (low turnover) outperform their colleagues who trade frequently (high turnover). One of the reasons for this is that the former spend less on trading commissions than the latter. Trading costs are coming down, but they can still represent a significant fund expense.
  2. These trading costs are not included in a fund's expense ratio. Thus, transaction costs are often ignored by investors because they are buried as a dollar figure, as opposed to a percentage of assets, in a fund's Statement of Additional Information (SAI). It is likely that only a tiny fraction of mutual fund investors are even aware of this document, let alone familiar with its content. (To learn more, read Stop Paying High Fees.)

    According to 2005 Lipper Services data, trading commissions add, on average, an additional 0.15% to fund expenses. While the percentages may seem small, it can significantly ding returns over time. For example, consider two hypothetical $10,000 investments over 20 years in different funds with nontrading (operational) expenses of 1%, one with trading costs of 0.5% and the other with trading costs of 1%. Assuming annual growth of 8%, an investor would end up with just under $34,500 in the first fund and about $31,100 in the second. The $3,400 difference represents a significant 11% bonus in return for fund No.1 over fund No.2.

  3. The components of an index fund change infrequently, which puts these types of funds in a low trading mode. However, unlike index funds, managed funds have human beings at the controls. And, the greater the number of trades, the more often the manager has to be making the right decision. A high volume of trading places a lot of pressure on managers to avoid making mistakes in investing judgments. (For related reading, see The Lowdown On Index Funds.)

  4. A high level of fund trading activity generally occasions a higher-than-average amount of capital gains. Mutual funds must pay out these gains as dividends to fund shareholders, which are then subject to capital gains taxes. For investors in taxable funds, i.e., not in tax-deferred accounts, high portfolio-turnover funds are not tax efficient.

The Benefits Of Low Turnover
A low portfolio turnover rate is a very positive fund investment quality. However, it must be remembered that the nature or investing style of a fund can impose certain "structural" features on portfolio management that influence its trading activities:

  • Small-cap stock, international and growth funds tend to have higher turnover rates. These funds are more transaction-intensive as the managers maneuver for competitive advantages.
  • Index funds should have low turnover rates, no matter what their category.
  • Trading is a natural function of bond funds, which puts their turnover rates way up on the scale. (To learn more about this type of fund, see Evaluating Bond Funds: Keeping It Simple.)
  • Funds that carry only a small number of securities in their portfolios oftentimes reflect high turnover rates because of the impact of a single trade on a major holding.
Whatever the category of mutual fund being considered, the lower the portfolio turnover percentage the better. While this measurement may vary from year to year, a fund's trading activity is within the control of the manager and should consistently fall, historically, within a reasonable range.

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Scoring Fund Turnover Data

  1. Portfolio Turnover
  2. Fund I-Q No. 5: Portfolio Turnover Ratio
  3. Scoring Fund Turnover Data
RELATED TERMS
  1. Turnover Ratio

    The percentage of a mutual fund or other investment vehicle's ...
  2. Annual Turnover

    The percentage rate at which a mutual fund or exchange-traded ...
  3. Portfolio Turnover

    A measure of how frequently assets within a fund are bought and ...
  4. Fund Of Funds

    A mutual fund that invests in other mutual funds. This method ...
  5. Total Annual Fund Operating Expenses

    For a mutual fund or other type of fund management structure, ...
  6. Mutual Fund

    An investment vehicle that is made up of a pool of funds collected ...
RELATED FAQS
  1. What is a good turnover ratio for a mutual fund?

    Learn about mutual fund turnover ratios and why the ideal ratio may differ based on the type of mutual fund and your investment ... Read Answer >>
  2. How should I use portfolio turnover to evaluate a mutual fund?

    Learn about the turnover rate for mutual funds, and understand the effect higher turnover may have on fund performance and ... Read Answer >>
  3. What is considered a good turnover ratio for a mutual fund?

    Understand what the concept of turnover ratio represents in relation to a mutual fund, and how an investor can evaluate a ... Read Answer >>
  4. What does a high turnover ratio signify for an investment fund? (KNOW)

    Find out more about the turnover ratio, what the turnover ratio measures and what a high turnover ratio indicates about an ... Read Answer >>
  5. How can a mutual fund raise or lower its turnover ratio?

    Find out how a fund manager can raise or lower a fund's turnover ratio, including how to interpret this metric and what it ... Read Answer >>
  6. Why do index funds tend to have low expense ratios?

    Understand what an index fund is and why the nature of index funds causes them to have lower expense ratios than more actively ... Read Answer >>

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