Portfolio Turnover

Article byRutan Bhattacharyya
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Portfolio Turnover?

Portfolio turnover is the rate at which the portfolio managers of a fund purchase and sell financial securities over a given period, usually a year. Investors must consider this key metric as the higher the turnover ratio, the more the associated fees, reflecting the turnover costs.

Portfolio Turnover

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Portfolio Turnover (wallstreetmojo.com)

Typically, a fund with a high turnover rate implies that investors must pay high capital gains taxes. That said, a high ratio is justified when the portfolio manager can generate higher risk-adjusted returns compared to the same funds with a low turnover rate. This ratio offers individuals an insight into how portfolio managers manage the investment corpus.

Key Takeaways

  • Portfolio turnover meaning refers to the frequency with which a fund’s portfolio manager makes changes to the portfolio over twelve months.
  • Investors must consider it a crucial aspect before deciding whether to invest in a fund.
  • Unlike the holding period, the turnover rate does not determine whether an investor has to pay a tax on short-term or long-term capital gains.
  • Portfolio turnover in mutual funds can help individuals know whether the fund managers have used the fund’s corpus efficiently. Moreover, it gives individuals an idea regarding the strategies utilized by portfolio managers.

Portfolio Turnover Ratio Explained

Portfolio turnover meaning refers to the percentage change of a fund’s assets, usually for twelve months. The turnover rate impacts the returns generated by a mutual fund or a similar investment option. Therefore, investors must check this key metric before allocating their money to any fund.

A high turnover rate signifies that fund managers frequently change the portfolio’s assets using a fast-paced or active investment strategy. As a result, they incur high transaction costs, which are charged to a fund. This, in turn, can impact the fund’s returns. On the other hand, a low turnover rate (less than 30%) indicates that the fund manager is using a buy-and-hold strategy to generate returns.

Funds with a high turnover rate are actively-managed funds. In contrast, funds with a low turnover rate are passively-managed funds. A turnover rate of 100% or more indicates that the fund manager sold or replaced every financial instrument with another security over a year.

Investors must remember to compare this ratio of mutual funds falling under the same fund category. For example, one can compare the ratios of two large-cap funds. However, they cannot compare the turnover rate of a small-cap fund against that of a balanced fund.

The following points can give an idea of the turnover rate’s importance:

  • It offers a clear picture regarding fund management.
  • It influences a mutual fund’s expense ratio.
  • This ratio helps individuals spot discrepancies. For example, it can indicate whether a fund manager mismanaged the investment corpus.

Lastly, investors can track this ratio of any mutual fund to determine the strategy the fund manager uses. For instance, a surge in the turnover rate from 20% to 70% would indicate that the portfolio manager is using a completely different investment strategy.

Financial Modeling & Valuation Courses Bundle (25+ Hours Video Series)

–>> If you want to learn Financial Modeling & Valuation professionally , then do check this ​Financial Modeling & Valuation Course Bundle​ (25+ hours of video tutorials with step by step McDonald’s Financial Model). Unlock the art of financial modeling and valuation with a comprehensive course covering McDonald’s forecast methodologies, advanced valuation techniques, and financial statements.

Portfolio Turnover Rate Formula

Individuals can use the following formula to calculate portfolio turnover:

Portfolio Turnover Rate = (Minimum of Financial Instruments Purchased or Sold ÷ Average Net Assets) x 100

Where:

  • The minimum of financial instruments purchased or sold is the overall amount of financial securities bought or the total dollar amount of financial instruments sold by the portfolio manager (whichever is lower) over a year.
  • ‘Average net assets’ is the monthly average amount of all net assets in the fund’s portfolio.

Calculation Example

Let us look at this portfolio turnover calculation example to understand this concept better.

Suppose SilverRock Fund bought and sold financial instruments worth $15 million and $18 million, respectively. Over twelve months, the mutual fund held $36 million of average net assets. Individuals can calculate the portfolio turnover of this fund using the above formula.

Portfolio Turnover = ($15 million / $36 million) x 100 i.e., 41.67%

Portfolio Turnover vs Holding Period

Individuals new to the investment world often fail to understand crucial concepts like portfolio turnover and holding period. Yet, knowing their meanings is essential to make the right investment decisions and fulfilling the set financial goals. So, let us look at the distinct features of portfolio turnover and holding period.

Portfolio TurnoverHolding Period
It indicates the rate at which a mutual fund’s portfolio managers buy and offload stocks, bonds, or any other financial instrument over twelve months.  The holding period is the duration for which investors hold a financial instrument. In other words, it is the period between the date of purchase and the sale date of financial security.
This ratio provides insight into the strategies used by fund managers. Moreover, it influences a fund’s expense ratio and impacts the returns.A financial asset’s holding period determines its tax implications; investors pay short-term or long-term capital gains tax based on this period.

Frequently Asked Questions (FAQs)

Is a high portfolio turnover rate good?

Usually, a higher turnover rate indicates increased expenses for mutual funds, which negatively impacts a fund’s performance. Moreover, funds with a higher turnover rate pay more capital gains taxes than funds having a lower rate. That said, choosing a mutual fund with a high portfolio turnover ratio can still make sense if it delivers a higher risk-adjusted return than a fund with a lower turnover rate.

Is low portfolio turnover good for mutual funds?

Usually, a lower turnover rate indicates higher returns for investors. Mutual funds with a low turnover rate incur lower costs to run the fund. As a result, they typically charge a lower expense ratio than funds with a high turnover rate. This leads to higher returns for investors.

Can portfolio turnover be negative?

The turnover rate cannot be negative. When the rate is 0, the portfolio manager did not make any changes over the past year.

What is low portfolio turnover?

Generally, 30% or less portfolio turnover in mutual funds is considered low. It suggests that the portfolio manager is using a passive investment strategy to generate returns for the investors.

This has been a guide to what is Portfolio Turnover. Here, we explain its formula, rate calculation, example, and comparison with the holding period. You can learn more about finance from the following articles –

Reader Interactions

Leave a Reply

Your email address will not be published. Required fields are marked *