What Does Total Asset Turnover Indicate?
When you review the prospectus for a mutual fund you are considering investing in, one of the numbers you should look at is the turnover ratio. The turnover, sometimes called the total asset turnover, is an indication of how often a particular mutual fund changes the stocks in its portfolio. While a high turnover in itself is neither good nor bad, it is one more thing to consider when choosing a stock market investment. The turnover rate of a mutual fund is expressed as a percentage, and it is calculated by dividing the average assets of the fund by the value of purchases or sales, whichever is less.
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High Capital Gains
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One of the potential problems of investing in a fund with a high total asset turnover ratio is that the fund is likely to generate high levels of capital gains. If you hold that fund in a taxable account, you must pay taxes on all the capital gains the fund generates, even if you reinvest those gains to buy additional shares. If you are investing with personal money, it is important to look at the amount of capital gains that fund has generated in the past to get an idea of the taxes you may have to pay once you own that fund.
Best for Retirement Funds
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Because a mutual fund with a high asset turnover tends to generate a lot of capital gains, these funds typically are better suited for tax-deferred vehicles such as IRAs and 401k plans. With a tax-deferred investment, you do not have to pay any capital gains taxes along the way, so the turnover ratio is not as important. You still need to consider other things, such as the cost of the fund and the types of stocks it holds.
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Expenses
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Each time a mutual fund buys or sells a stock, it incurs expenses associated with that trade. These expenses include the brokerage fee, the taxes incurred on that trade and the research that went into the decision to buy or sell. All those expenses are passed on to the investors in the fund, and mutual funds with high asset turnover often have high expenses as well. Analyzing the total costs of a mutual fund is always important, but you may need to scrutinize a fund with a high turnover ratio more closely.
Managed Fund
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A high total asset turnover ratio indicates you are dealing with a managed fund rather than an index fund. An index fund buys and holds all the stocks in a given index, and it only makes trades when the underlying makeup of that index changes and a particular stock is added to or removed from the index. However, a managed fund buys and sells stocks much more often, which increases the turnover ratio for the fund.
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