Mutual fund turnover is a term used to describe the variation in a mutual fund's portfolio in a single year. This measurement is generally represented as a ratio and is calculated by taking the total amount of purchase and sale transactions within a mutual fund in a single year, dividing that total by two, and then dividing that total by the current amount of holdings in the portfolio. A high mutual fund turnover rate can be problematic to investors because it can cut into returns due to transaction expenses and tax consequences. It is best to compare the turnover of funds with similar strategies to see which are the most cost-efficient.
A mutual fund is a managed investment opportunity that pools together funds from multiple investors and uses that capital to make a broad range of investments. The value of a fund is determined by the net asset value of all of the securities it holds. Typically, investors reap rewards in the form of capital gains. Portfolio managers are in charge of choosing which securities are to be bought and sold, and all of these transactions, known as mutual fund turnover, have an effect on the return on investment for the fund's investors.
As an example of how mutual fund turnover is calculated, imagine that a fund has bought and sold a total of $50,000 US Dollars (USD) of securities in a year and currently has holdings of $100,000 USD. The first step is dividing the $50,000 USD by two, leaving a total of $25,000 USD. That number is divided by the total holdings of $100,000 USD for a quotient of .25. This means the fund had a turnover of 25 percent.
The mutual fund turnover is important because a high turnover can drain the returns available to investors. Every time a security within a fund is bought or sold, a commission fee is passed on to the fund's investors. In addition, when securities within a fund are sold, the capital gains that are amassed are taxable, which also reflects poorly upon the investor's return.
It is chiefly only valuable to compare the mutual fund turnover ratio for funds with similar portfolio strategies. For example, growth funds tend to be more aggressive with buying and selling securities. Value funds are more likely to buy and hold the securities that they deem to be underrated by the market, thereby causing a lower turnover than what is found in growth funds. Comparing the turnovers of funds with different goals can lead to incorrect conclusions.