"Turnover ratio" is a phrase frequently used to describe mutual funds. What does that mean, though? And how does it support investment decisions? You can learn much about mutual funds by looking at various statistics and metrics. Many of them can assist you in determining whether to include a fund in your portfolio or not. Others are not required for successful investing. However, understanding a mutual fund's turnover ratio can provide some crucial information regarding the direction that fund may be taking. Its potential future performance and taxation may be included.
Main Points
- The turnover ratio reveals what proportion of a mutual fund's holdings was changed over the previous year.
- Low turnover rates frequently translate into lower expenses and higher profits.
- More active fund management is frequently indicated by higher turnover ratios, which raises expenses and taxes.
- When evaluating ratios, you should compare similar funds in terms of type because average turnover ratios differ between mutual fund types.
What Does the Mutual Fund Turnover Ratio Mean?
A mutual fund's turnover ratio indicates the number of its holdings that were replaced (or "turned over") during the previous year. This informs you of the frequency with which a fund switches out some assets for others. Let's say a mutual fund buys 100 stocks and, after a year, replaces 50 of them. That would result in a turnover ratio of 50%.Why Is There Such a High Turnover Ratio?
A fund with a higher turnover typically has higher trading expenses. Its expense ratio serves as a gauge for this. Additionally, the fund will pay more taxes than a fund with a lower turnover. Why are high turnover funds more expensive? More analysis and research lead to more trades. It is more expensive and time-consuming. Additionally, trades frequently have transaction costs. With actively managed mutual funds, high turnover is most typical.What Is the Meaning of a Low Turnover Ratio?
A fund with a low turnover ratio is likely to continue investing primarily in the same stocks. This might imply that an actively managed fund manager employs a buy-and-hold strategy. But passively managed funds typically have a low turnover ratio. These might be exchange-traded funds or index funds (ETFs). Higher net returns frequently result from lower turnover. Low turnover funds require less time to manage, which results in lower operating expenses for the mutual fund. You will benefit from these cost savings. Distributions of capital gains account for the majority of the higher tax costs. You must pay taxes when a mutual fund manager sells securities that you have appreciated. Additionally, you receive these.What Turnover Levels Are Ideal?
Depending on the type of fund you are considering, turnover ratios change. Bond and small-cap stock funds are two examples of mutual fund types or categories with relatively high turnover rates. It might be greater than or equal to 100%. When compared to other types of funds, other funds, like index funds, will have a lower turnover. They could have a turnover of 10% or less. A low turnover ratio is typically between 20% and 30% for all types of mutual funds. Over 50% is considered a high turnover ratio. The majority of ETFs and index funds have lower turnover ratios. But comparing a mutual fund to other funds of the same type is the most effective way to figure out the ideal turnover for a particular mutual fund type. Then, to save money, you might want to select investment funds with a lower turnover ratio. You might decide to look for small-cap funds with turnover ratios below the average value, such as if the average small-cap stock fund has a turnover ratio of 90%.When Is the Turnover Ratio Useful?
The turnover ratio of a fund can reveal crucial information about its management. It can also aid in determining whether investing in it will cost more or less than other funds of the same kind. However, the turnover ratio alone cannot advise you whether or not to invest in a specific mutual fund. Turnover only gives you a portion of the overall picture of a fund, like many other metrics used for mutual fund analysis. Before choosing where to put your money, you should always research and examine a fund's other metrics.