What Is Turnover Ratio?
A turnover ratio or turnover rate in investing is the percentage of a mutual fund or other portfolio holdings that have been replaced in the course of one year.
Some funds hold their equity positions for less than 12 months, meaning their turnover ratios exceed 100%. That doesn't necessarily mean that every holding has been replaced. The ratio reflects the proportion of stocks that have changed in one year.
Key Takeaways
- The turnover ratio varies by the type of mutual fund, its investment objective, and the portfolio manager's investing style.
- 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.
- Funds with high turnover ratios can incur greater costs in trading fees and commissions and may generate short-term capital gains, which are taxable at an investor's ordinary-income rate.
Understanding Turnover Ratio
The turnover ratio varies by the type of mutual fund, its investment objective, and the portfolio manager's investing style.
For example, a stock market index fund will have a low turnover rate since it duplicates a particular index and replaces holdings only when the index changes. An actively traded mutual fund may have a high turnover rate, depending on how aggressively its manager buys and sells holdings in search of better returns.
Actively managed mutual funds with a low turnover ratio reflect a buy-and-hold investment strategy. Funds 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 Different Meanings of "Turnover Ratio"
- In the mutual fund industry, turnover ratio is the percentage of the fund's holdings that have been replaced in the course of one year.
- In business, turnover ratio is a measurement of efficiency, indicating the length of time it takes a business to sell the goods that it has spent money up front to acquire.
- In a company or industry, turnover ratio is the percentage of employees who leave within a year.
The Significance of Turnover Ratio
As a technical indicator, the turnover ratio itself has no intrinsic value. A high turnover ratio is not necessarily bad, nor is a low turnover ratio 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. These increased costs are passed on to the investors, and are reflected in the fund's return overall.
Also, the more portfolio turnover in a fund, the more likely it is generate short-term capital gains. These are profits on assets held for less than one year and are taxable at an investor's ordinary-income rate, which is often higher than the capital gains rate.
How to Read Turnover Ratio
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 of investment approach.
The average turnover ratio for managed mutual funds is 75–115%. So, a conservative-minded equity investor might target funds with turnover ratios under 50%.
If a fund's turnover ratio is significantly out of line with that of comparable funds, it might be something to note.
Say that most funds in a particular sector have turnover ratios around 5%, but one fund posts 25% turnover in one year. In this instance, the investor might want to know why. Did a new portfolio manager come in and decide to wipe the slate clean? Was there a change in the fund's objective?
Or, say that most funds in another sector have 75% turnover ratios, but there is one with a ratio of 35%. Is management there asleep at the wheel?
Turnover ratio alone shouldn't be a deciding factor, but an abnormally high or low ratio among comparable funds is a reason to look harder at the fund's performance over time to see just how successful its strategy has been.
Formula and Calculation of Turnover Ratio
The turnover ratio will be listed in the company's prospectus for the mutual fund. It would be difficult for an investor to work it out, since it would require knowing the sales price of every transaction made during the year and the average monthly net value of the fund over 12 months.
The formula is as follows:
Total dollar value of all new portfolio assets (or value of portfolio assets sold, if that is the smaller), divided by monthly average net assets of the fund in dollars, times 100.
Examples of Turnover Ratio
The BNY Mellon Appreciation Fund from Fidelity (DGAGX) 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 2022, the fund's turnover ratio was a bit over 9.%.
Fidelity's Rydex S&P Small-Cap 600 Pure Growth Fund (RYSGX) 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. At the end of March 2022, the Rydex fund had an average turnover ratio of 707%.
What Is a Turnover Ratio in a Business?
Turnover ratio has a variety of meanings outside of the investing world.
A turnover ratio in business is a measurement of the firm's efficiency.
It is calculated by dividing annual income by annual liability. It can be applied to the cost of inventory or any other business cost.
Unlike in investing, a high turnover ratio in business is almost always a good sign. It may show, for example, that the business is selling its stock out as quickly as it can get it in.
What Is a Turnover Ratio in a Company?
Perhaps the most common use of a turnover ratio is to measure the proportion of a company's employees who are replaced during a year.
A low employee turnover rate indicates that people seldom leave the company. A high turnover rate means they're fleeing in large numbers.
There's no good or bad turnover rate. Some industries have high turnover rates by their nature. Information technology has a high turnover ratio because its employees are in high demand elsewhere. The retail and hospitality industries have high turnover ratios because their jobs are ill-paid and tough to do.
How Do I Check the Turnover Ratio for My Mutual Fund?
You should find turnover ratio (or turnover rate) in the issuing company's latest financial statement on the mutual fund.
For example, Vanguard lists the turnover rate for its Vanguard Health Care Fund Investor Shares as 14.9% as of Feb. 28, 2023. It is an item in its "Fundamental" list for the fund.
The Bottom Line
Turnover ratio alone won't help you determine whether a mutual fund is the right choice for you. It simply tells you what percentage of stocks and other assets in the fund have been replaced in the course of the year.
It could be relevant to your research into mutual funds, however. If comparable mutual funds have higher or lower turnover ratios than the fund you're looking at, it's a signal to look further into the fund's performance. You may find that it's achieving better returns over time due to all of that activity, or lack of activity. If it's not, you might look at rival funds for a better choice.
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Turnover Ratio in Investing:
Definition: The turnover ratio, or turnover rate, in investing refers to the percentage of a mutual fund or portfolio holdings that have been replaced within one year.
Variation: The turnover ratio varies based on the type of mutual fund, its investment objective, and the portfolio manager's investing style.
Factors Influencing Turnover Ratio:
- Investment Objective: Different funds with distinct objectives exhibit varying turnover ratios.
- Manager's Style: Actively managed funds may have higher turnover, reflecting an aggressive buying and selling approach.
- Market Conditions: Economic and market conditions can impact turnover ratios.
Impact of Turnover Ratio:
- Costs: Funds with high turnover ratios may incur greater trading fees and commissions.
- Tax Implications: High turnover can lead to short-term capital gains, taxed at higher rates.
Reading Turnover Ratio:
- Comparison: Comparing a fund's turnover ratio with others of the same type provides insights into its investment approach.
- Abnormal Ratios: Abnormally high or low ratios among comparable funds warrant further investigation into a fund's performance.
Formula and Calculation:
- The turnover ratio is calculated using the formula: (Total dollar value of all new portfolio assets or value of assets sold) / (Monthly average net assets of the fund) * 100.
Examples:
- BNY Mellon Appreciation Fund (DGAGX): A buy-and-hold strategy with a turnover ratio slightly over 9%.
- Fidelity's Rydex S&P Small-Cap 600 Pure Growth Fund (RYSGX): Actively managed with an average turnover ratio of 707%.
Turnover Ratio in Business:
- Efficiency Measurement: In business, turnover ratio measures efficiency, calculated by dividing annual income by annual liability.
Employee Turnover in Companies:
- Common Usage: It measures the proportion of employees replaced in a company within a year.
- Industry Variation: Different industries may have high or low turnover rates, influenced by factors like demand and job nature.
Checking Turnover Ratio for Mutual Funds:
- Source: Investors can find turnover ratios in the issuing company's latest financial statements on the mutual fund.
The Bottom Line:
- Decision Factor: Turnover ratio alone doesn't determine a fund's suitability but can be a signal for further investigation into its performance.
- Comparison: Comparing turnover ratios with comparable funds helps investors assess relative performance.
Understanding turnover ratios is crucial for investors to make informed decisions and align their investment strategies with their financial goals.
