Turnover Ratios: Weak Indicators of Fund Quality

Turnover ratios are statistics commonly used when evaluating the prospects of mutual funds. A turnover ratio looks at the amount of buying and selling that goes on with the underlying investments of a fund. While this information can be good to look at, it is generally not a good way to determine the quality of a fund. Here are a few things to consider about the importance of turnover ratios.

Turnover Ratio

The turnover ratio of a mutual fund is calculated by first adding up all of the fund's transactions. This includes all of the buying and all of the selling that takes place over a certain amount of time. This is usually calculated on an annual basis. Then you will need to divide that number by 2. At that point, you divide that number by the total holdings of the fund. The turnover ratio is usually described as a percentage of the total assets in the fund. 

What It Tells You

This statistic is designed to tell you how much of your fund's assets are changed during the course of a year. If all of the fund's assets are turned over during the course of year, it has 100 percent turnover. Many funds have more than 100 percent turnover because they change all of their assets and then some over the course of a year. When you are evaluating a new fund, you should look at the turnover ratio. This will give you an idea as to the fund's investment strategy.

Buy and Hold

Some funds tend to buy and hold securities more than others. For example, if you invest in a value fund, it will most likely have a very low turnover ratio. With this type of investment strategy, the managers look to purchase undervalued stocks. Once they have purchased the stocks, they hold onto them for a certain amount of time until they are back up to the value that they should be at. With this type of strategy, they generally do not buy a lot of different stocks over the course of a year. 

Bond Funds

If you are thinking about investing in a bond fund, you will most likely have to deal with a high turnover ratio. As part of bond investing, the fund manager has to buy and sell bonds frequently. With this type of trading, the fund manager has to buy and sell in order to generate profits for the fund. These funds typically have turnover that is very close to 100 percent. 

Low Turnover

If you can find one, a fund with low turnover would be ideal. With this type of fund, there will be lower transaction costs. Since the transaction costs of the fund will be much lower, you will potentially be able to increase your return on investment overall. Finding funds with low expense ratios can make a big difference in your success as an investor over the long term.

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