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Introduction - Turnover

In an investment portfolio, turnover refers to the number of shares traded in a given period. Expressed as a percentage, it tells us what portion of the securities (stocks, bonds or both) in a fund's portfolio are bought and sold during the course of a year.

The four major reasons investors should be concerned about turnover include:

  • 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.
  • 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.
  • 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.
  • 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.

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.
  • 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.

While this list of terms is by no means comprehensive, it does lay a foundation on which you can build your investment knowledge. To learn more, keep reading.

Related Reading:

Reading A Prospectus


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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. Turnover

    1. In accounting, the number of times an asset is replaced during ...
  5. Overall Turnover

    A synonym for total revenues, commonly used in Europe and Asia. ...
  6. Receivables Turnover Ratio

    An accounting measure used to quantify a firm's effectiveness ...
RELATED FAQS
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  2. 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 >>
  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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