Importance of Turnover Ratio in Mutual Funds

Posted by Advisorymandi on June 20th, 2018

“Do you know about the turnover ratio in mutual funds?”

Well, if you are an expert investor or professional who has been in investing in mutual funds for years must know about the turnover ratio. But, the beginner investors or digital participants who are new to the field of mutual funds aren’t sure what it is. But, the turnover rate is very important in the context of mutual funds. It is also known by turnover ratio and represents the percentage of an MF or other investment’s holding that have changed over a time period (mostly, a year). The turnover ratio varies with the investment objective, type of mutual fund, and portfolio manager’s investment style.

Somehow, it helped in checking the performance of different mutual fund schemes. To better understand this, let’s assume a mutual fund is investing in 100 stocks and replacing 40 stocks during a year has a turnover ratio of 40 percent.

So, the turnover ratio can vary from 0 to 100 percent. However, the average turnover rate of managed MFs is approximately 85 percent and sometimes for other MFs, it could exceed 100 percent. It is because of the actively managed fund with the sole reason of generating an aggressive rate of return; the fund could have a much higher turnover ratio.

How to use portfolio turnover to weigh up a mutual fund?

In calculating the portfolio turnover, one must take the fund’s acquisitions or dispositions whichever number is greater and divide it by the average monthly assets of the fund for the year. But, the higher turnover rates or ratios mean increased fund expenses, which can ultimately reduce the fund’s overall performance. The funds which have higher turnover rates are a more likely to experience capital gain taxes. Thus, investors have to pay taxes on those capital gains.

 But, if a portfolio has a low turnover, it could mean that the fund follows a buy and hold strategy.

Final Thoughts: -

It is a measure of the total change in the holdings over a time period in a mutual fund so it plays a major role in mutual funds. A high turnover with high returns is given but a high turnover with lower returns definitely an indicator for review.