What Is a Turnover Ratio?
The definition of what constitutes a good turnover ratio—or turnover rate—for a mutual fund depends entirely on the type of fund you are considering and your goals for the investment. 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.
- Turnover ratios can vary widely from fund to fund, but usually fall between 0-100%. Ratios can exceed 100% if there is considerable turnover.
- Index funds should see low turnover rates since they are passively managed for the most part.
- Active funds see much higher turnover, but they are rebalanced in order to mitigate risk and adjust their portfolios during market swings and client input.
Understanding Turnover Ratios
A turnover ratio is a simple number used to reflect the amount of a mutual fund's portfolio that has changed within a given year. This figure is typically between 0% and 100%, but can be even higher for actively managed funds. A turnover rate of 0% indicates the fund's holdings have not changed at all in the previous year.
A rate of 100% means the fund has a completely new portfolio than it did 12 months ago. Everything it owned before has been sold, though not necessarily at the same time, and new investments have been made to replace those assets. A fund with a rate of 100% has an average holding period of less than a year. Some very aggressive funds have turnover rates much higher than 100%.
If you are investing in an indexed mutual fund, the passive nature of the security naturally means its turnover ratio should be very low. Indexed funds, as the name implies, are built to track given indexes and require almost no hands-on management. Stocks are only added or removed from the fund when the underlying index posts a change. An indexed fund with a high turnover rate is not being properly managed. Anything over 20% to 30% should be viewed with skepticism.
If you are investing in a mutual fund with the goal of generating rapid returns, you are looking at a higher turnover rate. The type of management strategy these funds employ is based on finding undervalued stocks, selling high and making the most of opportunities, which means there can be a lot of buying and selling during any given year. Though active funds may not always have very high turnover rates, an active fund that boasts high returns with low turnover is rare.
Some portfolio managers and asset managers find exceptionally high turnover to usually be indicative of a process called "churning," where a manager shuffles around a client's portfolio often in order to drum up trading commissions. Although this may be obvious when an investment professional reviews a trader's or manager's portfolio it can be less obvious to someone without as much formal financial education. For this reason, make sure to compare turnover ratios and commissions paid to a certain fund against those of their competitors.