How to Read Your Funds Turnover Ratio

Turnover ratio is the percentage of a mutual fund's holdings that are sold every year. Funds with a high turnover ratio generally mean more fees, more capital gains and more capital gains tax for shareholders. Actively managed funds often have higher turnover ratios (on average about 80-85%) than passively managed funds or index funds, which average around 5% turnover. The more aggressive the fund is, the more likely it is to have a high turnover ratio.

Difficulty: Easy

Instructions

Things You'll Need:

• Basic investment vocabulary or dictionary
• The prospectus of the mutual fund in which you are interested

Understand Your Fund's Turnover Ratio

1. Open the mutual fund's prospectus to the fees and expenses page and read through the funds and expenses for the turnover ratio.

2. Remember that a high turnover ratio generally means greater volatility and higher costs and taxes.

3. Find a mutual fund with a turnover ratio of 50% or less to minimize possible fluctuations that could negatively affect the fund.

4. Consider investing in an index fund. Aside from being low-risk, these funds average less than 10% turnover, as they are not trying to beat the market, just match it.

5. Avoid reading too much into dramatic increases or decreases in your fund's turnover. There are other factors that can artificially inflate or deflate the turnover ratio.

6. Read your prospectus and annual reports. If your fund's turnover ratio changes suddenly, check to see that the fund manager hasn't changed.

Tips & Warnings

• Turnover ratios are measured by dividing the amount of securities bought or sold (whichever is less) by the fund's average monthly assets for the year.
• High turnover ratios mean that the funds are buying and selling securities more often than those with low turnover ratios. Index funds have some of the lowest turnover ratios, often less than 10%.
• Listen to the manager. Fund managers typically issue quarterly or yearly updates, explaining their investing philosophy for the prior and upcoming quarters. Read these updates to make sure the fund manager's philosophy still reflects your investing goals.
• Keep your tax advisor in the loop. Investing in mutual funds can have significant tax consequences. Make sure your tax planner knows about the investments you plan to make.
• High turnover ratios are commonly linked to riskier investments. More turnover may also mean more realized capital gains and therefore more taxes, which the fund passes along to the investors.