What Is the Turnover Ratio?
The turnover ratio or turnover rate is the percentage of a mutual fund or other portfolio's holdings that have been replaced in a given year (calendar year or whatever 12-month period represents the fund's fiscal year).
For example, a mutual fund investing in 100 stocks and replacing 50 stocks during one year has a turnover ratio of 50%. Some funds hold their equity positions for less than 12 months, meaning their turnover ratios exceed 100%.
If a portfolio's turnover ratio exceeds 100%, it doesn't necessarily mean that every single holding has been replaced, however. The ratio seeks to reflect the proportion of stocks that have changed in the recent year.
The Basics of Turnover Ratio
The turnover ratio varies by the type of mutual fund, its investment objective and/or the portfolio manager's investing style. For example, a stock market index fund usually will have a low turnover rate, since it just duplicates a particular index, and the component companies in indexes don't change that often. But a bond fund will often have high turnover because active trading is an inherent quality of bond investments.
Actively managed mutual funds with a low turnover ratio reflect a buy-and-hold investment strategy; those with high turnover ratios indicate an attempt to profit by a market-timing approach. An aggressive small-cap growth stock fund will generally experience higher turnover than a large-cap value stock fund.
- The turnover ratio or turnover rate is the percentage of a mutual fund or other portfolio's holdings that have been replaced in a given year.
- The turnover ratio varies by the type of mutual fund, its investment objective and/or the portfolio manager's investing style.
- Funds with high turnover ratios might incur greater costs (trading fees, commissions) and generate short-term capital gains, which are taxable at an investor's ordinary income rate.
The Significance of Turnover Ratio
As a technical indicator, the turnover ratio itself has no intrinsic value—high turnover ratios are not necessarily "bad," nor are low turnover ratios necessarily "good." But investors should be aware of the consequences of turnover frequency. High turnover often results in increased costs for the fund due to the payment of spreads and commissions when buying and selling stocks; increased costs impact a fund's return overall. Also, the more portfolio turnover in a fund, the more likely it will generate short-term capital gains, which are taxable at an investor's ordinary income rate.
A mutual fund's turnover ratio shouldn't be the sole basis of a decision to invest or devest in it. However, it can be useful to see how a particular fund's turnover ratio compares with others of the same type or investment approach. For example, the average turnover ratio for managed domestic stock funds is 63% (as of late Februrary, 2019), according to Morningstar Research
Manager Michael Laske. So a conservative-minded equuity investor might target funds with turnover ratios under 50%.
if a fund's turnover ratio is greatly out of line with that of comparable funds, that might be significant. Say that most funds following a particular index have turnover ratios around 5%, and one fund posted 25% turnover in one year, investors might want to ask why: Did a new portfolio manager come in and clean house? Was there some change in the fund objective? Conversely, say that most Pacific Rim equity funds have 75% turnover ratios, but there is one with a ratio of 35%: Is management there asleep at the wheel?
Real World Examplse of Turnover Ratio
The Dreyfus Appreciation Fund from Fidelity has a strong buy-and-hold strategy in mostly blue-chip companies with total market capitalizations of over $5 billion at the time of purchase. Those companies show sustained profitability, strong balance sheets, global expansion, and above-average earnings growth, in keeping with the fund's objective of capital preservation. As of year-end 2018, the Dreyfus turnover ratio was 5.12%.
In contrast, Fidelity's Rydex S&P Small-Cap 600 Pure Growth Fund invests in the common stock of companies within the capitalization range of the underlying S&P Small-Cap 600 Index and derivative instruments. At least 80% of the fund’s net assets are invested in fast-growing companies or firms in up-and-coming industries, and it seeks to match the index's performance on a daily basis. The Rydex had an average turnover ratio of 818%.