The Portfolio Turnover Rate is a critical financial metric used to measure how frequently assets within a fund or investment portfolio are bought and sold over a specific period, typically one year. For investors, this rate reveals the investment strategy of the fund manager—whether they are active traders or follow a "buy and hold" philosophy.
A high turnover rate suggests an aggressive trading strategy, while a low turnover rate indicates a more passive or long-term approach. This figure is vital because trading incurs transaction costs and potentially triggers capital gains taxes, both of which can eat into an investor's net returns.
The Formula
Portfolio Turnover Rate = (Minimum of Total Purchases or Sales / Average Net Assets) × 100
The SEC (Securities and Exchange Commission) standardizes this by using the lesser of the total purchases or total sales divided by the average monthly net assets of the fund.
Why It Matters
Transaction Costs: Every trade involves brokerage commissions and bid-ask spreads. High turnover usually leads to higher internal expenses.
Tax Efficiency: Frequent selling often results in realized capital gains, which are passed on to shareholders in taxable accounts.
Investment Style: Rates below 20-30% usually signify long-term investing. Rates exceeding 100% indicate the entire portfolio has effectively been replaced within the year.
Practical Example
Scenario: The "Growth Alpha Fund" has the following annual data:
Total Purchases: $1,200,000
Total Sales: $800,000
Average Assets: $4,000,000
Calculation:
1. Identify the lower value between purchases and sales: $800,000.
2. Divide by average assets: $800,000 / $4,000,000 = 0.20.