Mutual funds can help diversify your investment portfolio. When comparing mutual funds, there are several key metrics to pay attention to, including the expense ratio and the turnover ratio. A mutual fund turnover ratio refers to how often the underlying assets in a specific fund are bought and sold. Turnover rates can vary greatly between different types of mutual funds and exchange-traded funds. We’ve answered what is a good mutual fund turnover ratio below or how this number is calculated. For further guidance on how best to integrate mutual funds into your investing strategy, consult with a trusted financial advisor.
Mutual Fund Turnover Ratio Explained
Mutual funds and exchange-traded funds (ETFs) are baskets of investments. They can include individual stocks, bonds, short-term cash instruments or other securities. A fund manager chooses what the mutual fund or ETF will hold and purchases those securities. Rather than buying individual stakes in all of these investments, a mutual fund allows you to own a little bit of everything in one convenient package.
But that doesn’t mean the underlying investments a fund owns remain the same. The fund’s manager can decide when to sell off underlying investments and add new ones to the fund. The rate at which this buying and selling occur is known as the mutual fund turnover ratio.
This is represented by a percentage and the higher the percentage, the more frequently a fund’s assets turn over. As a general rule of thumb, it’s more common to see higher turnover rates with actively managed mutual funds or hedge funds. Passively managed funds, including index funds and ETFs, tend to have a lower turnover rate.
The mutual fund turnover ratio is expressed as the rate of change over the course of a year. So, for example, if a fund has a turnover ratio of 50%, that means half of its investments were sold in the previous 12 months.
How Mutual Fund Turnover Is Calculated
Like other investing ratios, a mutual fund’s turnover rate can be calculated using a specific formula where you’ll need a couple very specific pieces of information. To calculate the turnover ratio for a fund you need to know:
- Purchased Securities: The total number of securities purchased by a fund for the 12-month period you’re calculating the ratio for
- Proceeds From Sale of Assets: The total proceeds realized from the sale of assets during that same 12-month period
It’s important to note that the Securities and Exchange Commission requires funds to calculate the turnover ratio using the smaller of those two numbers. So if you’re estimating the turnover ratio yourself, choose the smaller figure for your calculations to ensure accuracy.
Next, divide the number you’ve chosen by the fund’s assets, based on the average value for the 12-month period. You would then multiply the resulting figure by 100 to get the turnover ratio percentage.
So say you have a fund that bought and sold $10 million in assets over the previous year. The fund’s average assets were $40 million. If you divide $10 million by $40 million, you’d get 0.25, which means a 25% turnover ratio.
Why Turnover Ratio Matters for Mutual Funds
The turnover ratio is important when evaluating mutual funds or ETFs because it can tell you a lot about how the fund and the fund manager operate. It can also be helpful for managing investment costs.
Funds that have higher turnover ratios, for example, can trigger higher costs for investors. First, a fund that’s actively managed may charge a higher expense ratio to cover the fund manager’s services. The expense ratio represents the percentage you pay to own the fund on an annualized basis. At the low end, you can find index funds with expense ratios around 0.50% to 0.10%. But the most expensive funds can easily have expense ratios over 1%.
The turnover ratio can also give you an idea of what the fund’s investment strategy is, which is important for choosing funds that align with your goals and objectives. A growth mutual fund, for instance, may have a higher turnover ratio if the fund manager is constantly looking for the best growth stocks to drive returns. But a fund that uses a value investing approach may have a lower turnover ratio if the fund manager is buying assets that have the potential to appreciate over time.
That’s important to know if you’re a buy-and-hold investor. With buy-and-hold investing, you’re buying securities and holding on to them to realize capital appreciation, income from dividends or both. If you want funds that reflect that same approach, then choosing ones with a lower turnover ratio could be a good fit.
What Is a Good Mutual Fund Turnover Ratio?
There’s no specific ideal turnover ratio for a mutual fund or ETF. And a higher or lower turnover ratio isn’t necessarily a reliable indicator of how a fund has performed or will perform over time. Generally, passively managed ETFs and index mutual funds should have a lower turnover ratio. If a passively managed fund is turning over at a rate of more than 20% to 30%, that could suggest that the fund is being mismanaged.
With actively managed funds, there’s no such thing as a too-high ratio. It’s not uncommon to see a turnover of 50% of a fund’s assets or more in a given year with funds that take a more aggressive approach. What’s important to keep in mind is what the fund manager is doing to manage risk. Periodic rebalancing, for example, can help with minimizing risk while boosting returns, regardless of how often assets are turning over.
When comparing mutual funds, it’s important to look at the turnover ratio, the expense ratio, the fund manager’s overall track record and the fund’s underlying holdings. Checking the holdings can help you avoid becoming overweight in any one area. This can be particularly important if you’re using index funds to invest.
Say you have two funds, one that tracks the S&P 500 as its benchmark and another that tracks the Dow Jones U.S. Large-Cap Total Stock Market Index. Both of those indexes include large-cap companies, meaning those with a market capitalization of $10 billion or more. Holding both funds in your portfolio could cause you to be overexposed to large-cap holdings if you don’t have other funds to balance things out.
The Bottom Line
The mutual fund turnover ratio is a useful metric for evaluating mutual funds and deciding which ones belong in your portfolio. If you don’t want to calculate the turnover ratio yourself, you can easily find it by checking a fund’s prospectus. If you prefer to check fund and stock quotes online, you can also find turnover ratios listed along with other key fund characteristics on websites that track real-time market prices.
Tips for Investing
- Consider talking to your financial advisor about mutual fund turnover ratios when deciding how to invest. If you don’t have a financial advisor finding one doesn’t have to be difficult. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- When comparing mutual funds and exchange-traded funds, it’s important to understand how they differ. While mutual fund trades close at the end of the market day, ETFs trade on an exchange just like a stock. ETFs can be actively or passively managed and passively managed funds often carry lower expense ratios and turnover rates.
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