What is portfolio turnover? Portfolio turnover measures how often a fund buys and sells its holdings over a period (usually one year). It’s calculated by dividing the lesser of total purchases or total sales by the fund’s average assets for the period. The result is expressed as a percentage and indicates how actively a fund is managed. How turnover is calculated
* Formula: Turnover rate = (Smaller of total purchases or total sales) ÷ (Average assets for the period)
* Average assets is commonly estimated as the average of beginning and ending assets for the year (or average monthly assets).
* Example: Beginning assets $10,000; ending assets $12,000 → average = $11,000. If purchases = $1,000 and sales = $500, use the smaller number ($500): turnover = $500 ÷ $11,000 ≈ 4.54%.
Why turnover matters
* Transaction costs: Higher turnover usually means more brokerage commissions, bid/ask spreads, and trading fees. These costs reduce net returns and are often not reflected in the fund’s operating expense ratio.
* Taxes: Frequent realized gains generate capital gains distributions. Investors in taxable accounts may face higher tax bills, reducing after-tax returns.
* Performance trade-off: Active management (high turnover) can sometimes produce superior returns, but those gains must exceed the additional trading costs and taxes to benefit investors.
Managed vs. unmanaged funds
* Unmanaged (index) funds: Typically have low turnover because they replicate an index. Low turnover helps keep transaction costs and taxable distributions low—many broad index funds report turnover in the single digits.
* Actively managed funds: Tend to have higher turnover as managers buy and sell to pursue opportunities. Some active managers keep turnover low by adopting buy-and-hold strategies; others trade frequently.
* Historical evidence: Many studies show a large share of actively managed large-cap funds underperform their benchmarks after fees. However, a subset of active funds outperforms consistently.
Practical thresholds and signs to watch for
* Typical index funds: Turnover under 20–30% is expected; higher rates may indicate the fund deviates from passive indexing or is poorly managed.
* Very active funds: Turnover can approach or exceed 100% if the portfolio is almost completely replaced within a year.
* Evaluate in context: Turnover alone isn’t a quality measure. Consider it alongside strategy, historical performance after fees, and tax efficiency.
How to use turnover when choosing funds
* For taxable accounts: Prefer lower-turnover funds to reduce annual capital gains distributions and improve after-tax returns.
* For long-term investors: Lower turnover often aligns with buy-and-hold strategies that compound returns and minimize costs.
* For seeking alpha: If considering a high-turnover active fund, confirm the manager’s net-of-fees, after-tax track record and understand the additional trading costs you may incur.
* Compare turnover to peers and to the fund’s stated strategy to see if the level of trading is consistent with objectives.
Key takeaways
* Portfolio turnover quantifies how frequently a fund trades its holdings and is calculated as the lesser of purchases or sales divided by average assets.
* Higher turnover increases transaction costs and potential taxable distributions, which can lower net returns.
* Low-turnover funds (especially index funds) often provide cost and tax advantages, while high-turnover funds must deliver enough outperformance to overcome those disadvantages.
* Use turnover as one factor—along with fees, strategy, and performance history—when evaluating funds.
Explore More Resources