The turnover ratio is usually expressed in percent. For instance, if a fund purchased and sold $5 million in assets and had an average asset value of $50 million, then the resulting answer of 0.1 is translated to a turnover ratio of 10%.
What the turnover ratio means
Some look at turnover ratio as the percentage of the fund portfolio that got traded during the year, but that's not entirely precise, as repeated purchases and sales of individual holdings can boost turnover ratios even when many positions are left untouched. For instance, a turnover ratio of 100% doesn't mean that the fund bought and sold every single holding in its portfolio, but it does mean that there was extensive movement in and out of positions during the period.
There's no perfect turnover ratio for any fund, but the ratio gives you useful information about how the fund works. Actively managed funds with high turnover ratios rely on trading strategies to generate excess returns, and they generate higher trading costs that make it more difficult for the fund to produce market-beating returns.
Similarly, index funds should typically have low turnover ratios, trading only as much as is necessary to handle investor inflows and outflows. Even some actively managed funds have low turnover ratios, suggesting that they generally follow a long-term buy-and-hold strategy.
Before you invest in a mutual fund, make sure you know its turnover ratio. It will give you a better sense of how the fund manager thinks, and what action the manager is likely to take in response to changing conditions. Click here to choose a broker and start investing today.
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