What the Mutual Fund Turnover Ratio Means
Mutual fund turnover ratio is a measure of the changes in a mutual funds assets for a given period of time, usually one year. Mutual fund turnover is calculated by dividing the value of both the purchase and sale transactions for the period by two and dividing that figure by the total holdings of the fund. The ratio is used to measure trading activity with higher ratios usually indicating higher associated expenses. In addition, high turnover often means higher tax consequences (assuming the fund is not part of a retirement plan). A fund’s turnover ratio can vary from year to year, so it can be a good idea to look at average turnover over several consecutive years. All else being equal, investors usually prefer funds with low turnover ratios.
Turnover Ratios of Different Types of Mutual Funds
Growth funds tend to have high turnover ratios as managers of those funds seek companies and industries that demonstrate promise for growth. The challenge for growth fund managers, or manager of any high-turnover funds, is in achieving performance that compensates for the tax consequences associated with high turnover.
Value funds, on the other hand, offer an example of a type of mutual fund that typically has low turnover as managers of these funds tend to buy and hold stocks they believe to be undervalued.
Of course, the fund turnover ratio should not be the only factor for consideration when choosing a mutual fund for investment. Equally important are the fund’s objectives, management, historical performance, fees and expenses.
Turnover and Taxes
For many mutual fund investors, the tax bill for their mutual fund holdings can catch them off guard as, unlike holding individual stocks or other securities where you pay taxes on gains after shares are sold, distributions from the fund can create a taxable event. When fund managers sell securities within the fund, it can mean distributions and tax consequences to the fund investors.
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The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.
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