Portfolio Turnover Formula, Meaning, and Taxes (2024)

What Is Portfolio Turnover?

Portfolio turnover is a measure of how frequently assets within a fund are bought and sold by the managers. Portfolio turnover is calculated by taking either the total amount of new securities purchased or the number of securities sold (whichever is less) over a particular period, divided by the total net asset value (NAV) of the fund. The measurement is usually reported for a 12-month time period.

Key Takeaways

  • Portfolio turnover is a measure of how quickly securities in a fund are either bought or sold by the fund's managers, over a given period of time.
  • The rate of turnover is important for potential investors to consider, as funds that have a high rate will also have higher fees to reflect the turnover costs.
  • Funds that have a high rate usually incur capital gains taxes, which are then distributed to investors, who may have to pay taxes on those capital gains.
  • Growth mutual funds and any mutual funds that are actively managed tend to have a higher turnover rate than passive funds.
  • There are some scenarios in which the higher turnover rate translates to higher returns overall, thus mitigating the impact of the additional fees.

Understanding Portfolio Turnover

The portfolio turnover measurement should be considered by an investor before deciding to purchase a given mutual fund or similar financial instrument. That's because a fund with a high turnover rate will incur more transaction costs than a fund with a lower rate. Unless the superior asset selection renders benefits that offset the added transaction costs, a less active trading posture may generate higher fund returns.

In addition, cost-conscious fund investors should take note that the transactional brokerage fee costs are not included in the calculation of a fund's operating expense ratio and thus represent what can be, in high-turnover portfolios, a significant additional expense that reduces investment return.

100%

The turnover rate a very actively managed fund might generate, reflecting the fact that the fund's holdings are 100% different from what they were a year ago.

Managed Funds vs. Unmanaged Funds

The debate continues between advocates of unmanaged funds such as index funds and managed funds. S&P Dow Jones Indices, which publishes regular research on how actively managed funds perform compared to the S&P 500 index, claims that 75% of large-cap active funds underperformed the S&P 500 in the five years leading up to Dec. 31, 2020.

Meanwhile, in 2015, a separate Morningstar study concluded that index funds outperformed large-company growth funds about 68% of the time in the 10-year period ending Dec. 31, 2014.

Unmanaged funds traditionally have low portfolio turnover. Funds such as the Vanguard 500 Index fund mirror the holdings of the , whose components infrequently are removed. The fund registered a portfolio turnover rate of 4% in 2020, 2019, and 2018, with minimal trading and transaction fees helping to keep expense ratios low.

Some investors avoid high-cost funds at all costs. By doing so, there exists the possibility that they may miss out on superior returns. Not all active funds are the same and a handful of fund houses and managers actually make a habit out of consistently beating their benchmarks after accounting for fees.

Often, the most successful active fund managers are those who keep costs down by making few tweaks to their portfolio and simply buying and holding. However, there have also been a few cases where aggressive managers have made regularly chopping and changing pay off.

Portfolio turnover is determined by taking what the fund has sold or bought—whichever number is less—and dividing it by the fund's average monthly assets for the year.

Taxes and Turnover

Portfolios that turn over at high rates generate large capital gains distributions. Investors focused on after-tax returns may be adversely affected by taxes levied against realized gains.

Consider an investor that continually pays an annual tax rate of 30% on distributions made from a mutual fund earning 10% per year. The individual is foregoing investment dollars that could be retained from participation in low transactional funds with a low turnover rate. An investor in an unmanaged fund that sees an identical 10% annual return does so largely from unrealized appreciation.

Index funds should not have a turnover rate higher than 20% to 30% since securities should only be added or removed from the fund when the underlying index makes a change in its holdings; a rate higher than 30% suggests the fund is poorly managed.

Example of Portfolio Turnover

If a portfolio begins one year at $10,000 and ends the year at $12,000, determine the average monthly assets by adding the two together and dividing by two to get $11,000. Next, assume the various purchases totaled $1,000 and the various sales totaled $500. Finally, divide the smaller amount—buys or sales—by the average amount of the portfolio.

For this example, the sales represent a smaller amount. Therefore, divide the $500 sales amount by $11,000 to get the portfolio turnover. In this case, the portfolio turnover is 4.54%.

Portfolio Turnover Formula, Meaning, and Taxes (2024)

FAQs

Portfolio Turnover Formula, Meaning, and Taxes? ›

Portfolio turnover is calculated by taking either the total amount of new securities purchased or the number of securities sold (whichever is less) over a particular period, divided by the total net asset value (NAV) of the fund. The measurement is usually reported for a 12-month time period.

What is the formula for portfolio turnover? ›

Portfolio turnover is calculated by taking the lower of the total of new stocks purchased or sold over 12 months, divided by the fund's average assets under management (AUM).

Is portfolio turnover good or bad? ›

Generally speaking, a low turnover ratio is desirable over a high turnover ratio. The rationale is that there are transaction costs involved with making trades (buying and selling securities). In addition, funds with a higher portfolio turnover ratio are more likely to incur higher capital gains taxes.

How do you calculate investment turnover in accounting? ›

The turnover ratio measures fund yearly trading activity. It is calculated by taking the lesser of purchases or sales, dividing that number by average monthly net assets.

How to calculate turnover in accounting? ›

To calculate your annual business turnover, add your total sales from all 12 months in the last financial year. If you're a product-based business, this means the total money you received from the products you sold. Likewise, for a service-based company, your turnover is the total amount you charged for these services.

How does turnover rate affect taxes? ›

The rate of turnover is important for potential investors to consider, as funds that have a high rate will also have higher fees to reflect the turnover costs. Funds that have a high rate usually incur capital gains taxes, which are then distributed to investors, who may have to pay taxes on those capital gains.

What does portfolio turnover rate signify? ›

What is Portfolio Turnover Ratio? Portfolio Turnover Ratio is the frequency in which the assets held under a fund has changed over the years. In simpler words, PTR provides a measurement on how many times the fund managers bought or sold the assets under a fund over a period of time.

What is a good portfolio turnover ratio? ›

Understanding Turnover Ratios

This figure is typically between 0% and 100%, but can be even higher for actively managed funds. A turnover rate of 0% indicates the fund's holdings have not changed at all in the previous year.

Is 5% turnover good? ›

According to recruiting giant Monster, "every firm should establish its unique ideal rate." Pro tip: It's important to note that turnover rates vary significantly from industry to industry. However, turnover rates should (ideally) be lower than 10%, which is a very healthy turnover rate across the board.

Is 20% turnover bad? ›

Attrition above 20% is alarming & anything above 30% is serious injury to your business. If you have 50% turnover then it means over 80% of the people in your organization are actively searching for a job at all times.

What is a good capital turnover? ›

Experts say that a capital turnover ratio calculation of 1.5 to 2.0 is good. Higher is also better to a certain extent. If the number is too high, it's a working capital indicator that your available funds are too low.

What is the formula for ROI with turnover? ›

ROI can also be broken into two separate ratios, operating profit margin and asset turnover, which are multiplied together to get ROI as follows: Return on Investment = Operating income / Average operating assets Operating profit margin = Operating Income / Sales Asset turnover = Sales Average / Operating Assets Many ...

Is turnover the same as income? ›

Turnover is the total sales made by a business in a certain period. It's sometimes referred to as 'gross revenue' or 'income'. This is different to profit, which is a measure of earnings. It's an important measure of your business's performance.

Is turnover the same as revenue? ›

Revenue refers to the money companies earn by selling products or services for a price, whereas turnover is the number of times companies make or burn through assets. In reality, turnover affects the efficiency of companies, while revenue affects profitability.

Is turnover the same as profit? ›

Turnover is the net sales generated by a business, while profit is the residual earnings of a business after all expenses have been charged against net sales. Thus, turnover and profit are essentially the beginning and ending points of the income statement - the top-line revenues and the bottom-line results.

How do I calculate the NAV? ›

NAV=(Assets – Liabilities) / Total Shares

Net Asset Value is calculated as Net Asset of the Scheme / Outstanding Units. In this case, the net asset of the schemes may be estimated as the market value of the investments, receivables, other accrued income, and other assets.

What is the formula for turnover per year? ›

How to calculate annual turnover rate? To calculate turnover rate, we divide the number of terminates during the year by the number of employees at the beginning of that period. If we start the year with 200 employees, and during the year, 10 contracts are terminated, turnover is 10/200 = 0.05, or 5%.

References

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