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.
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 does a high portfolio turnover indicate? ›
A high portfolio turnover implies that the fund is churning the portfolio frequently; this results in high transaction costs (this is because every buy/sell trade in a stock involves a transaction cost), which are charged to the fund and, in turn, may affect returns.
What is the formula for investment turnover ratio? ›
The turnover ratio formula calculates the percentage of a portfolio's assets that have been replaced over a specific period, typically a year. Formula: Turnover Ratio = (Total Purchases + Total Sales) / Average Assets * 100.
How to calculate turnover? ›
“Take the total number of people leaving the job and divide that by the average number of people in the company [average the number of employees at the beginning and end of the time period].” Then, take that number and multiply it by 100 to get the employee turnover rate.
What is the formula for calculating stock turnover? ›
The formula to calculate the stock turnover ratio is cost of goods sold (COGS) divided by average inventory. The calculation of the stock turnover ratio consists of dividing the cost of goods sold (COGS) incurred by the average inventory balance for the corresponding period.
How to reduce portfolio turnover? ›
Strategies for Managing Portfolio Turnover
Additionally, utilizing low-cost investment products, such as index funds or ETFs, can lower management fees and turnover rates. It's essential to minimize market timing attempts, as these often lead to increased turnover and may result in lower returns.
How much turnover is considered good? ›
According to Gallup, 10% turnover is healthy, but every industry and every organization is different.
What turnover rate is too high? ›
Typically, high turnover means 28% of your new employees quit within the first 90 days of their employment. (Again: this presents an enormous cost to companies because they have to constantly repeat a cycle of recruitment, hiring, and training new people.)
What is a high turnover rate for a fund? ›
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.
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.
What is a good Sharpe ratio? ›
The Sharpe Ratio helps rank and indicate the expected return compared to risk: Usually, any Sharpe ratio greater than 1.0 is considered acceptable to good by investors. A ratio higher than 2.0 is rated as very good. A ratio of 3.0 or higher is considered excellent.
What is a good investment turnover? ›
Generally, passively managed ETFs and index mutual funds should have a lower turnover ratio. If a passively managed fund is turning over at a rate of more than 20% to 30%, that could suggest that the fund is being mismanaged. With actively managed funds, there's no such thing as a too-high ratio.
How do you calculate portfolio turnover? ›
Although the calculation methods may vary and some less popular methods account for adding and reducing the weight of individual positions, portfolio turnover is typically calculated by dividing total assets bought or sold during the period by the average monthly net assets for the period.
What is a good turnover ratio? ›
A good inventory turnover ratio is between 5 and 10 for most industries, which indicates that you sell and restock your inventory every 1-2 months. This ratio strikes a good balance between having enough inventory on hand and not having to reorder too frequently.
What is the formula for turnover ratio? ›
Inventory turnover ratio = Cost of goods sold * 2 / (Beginning inventory + Final inventory) The inventory turnover ratio is a measure of how many times your average inventory is "turned" or sold in a certain period of time.
What is the formula for turnover ratio in Excel? ›
The formula for turnover calculation is - (Number of exiting employees/Average number of employees) × 100. Let's break it down. Suppose an HR company had 250 employees at the beginning of January 2022, and 40 employees exited the company the same year.
What is the formula for account turnover ratio? ›
It measures how efficiently and quickly a company converts its account receivables into cash within a given accounting period. The AR Turnover Ratio is calculated by dividing net sales by average account receivables. Net sales is calculated as sales on credit - sales returns - sales allowances.
What is the formula for calculating the asset turnover ratio? ›
Asset Turnover Ratio = Net Sales / Average Total Assets
Net sales is the total amount of revenue retained by a company. It is the gross sales from a specific period less returns, allowances, or discounts taken by customers.
