What Is a Turnover Ratio? Definition, Significance, and Analysis

What Is a Turnover Ratio?

The 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.

Formula and Calculation of the 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:

Turnover Ratio = (Total dollar value of all new portfolio assets (or value of portfolio assets sold, if that is the smaller) / monthly average net assets of the fund in dollars) x 100

What the Turnover Ratio Can Tell You

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.

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. However, 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 to 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 the Turnover Ratio

A mutual fund's turnover ratio shouldn't be the sole basis of a decision to invest or divest 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.

A low turnover ratio is considered to be between 20% and 30% while a high turnover ratio is considered to be 100% or more. So, an investor willing to take some risk yet be somewhat conservative might target funds with turnover ratios around 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 a 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.

Examples of How to Use the 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 Dec. 31, 2023, the fund's turnover ratio was 3.76%.

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 31, 2023, the Rydex fund had an average turnover ratio of 812%.

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.