What is Turnover?

Turnover measures how much of a portfolio is bought and sold over a year. It is shown as a percentage of the portfolio's average value. A turnover of 10% means roughly a tenth of the holdings were swapped for something else during the year. A turnover of 100% means that, on average, the whole portfolio was replaced once. Investment funds publish this figure. It is usually calculated as the smaller of total purchases or total sales, divided by the fund's average assets. Using the smaller figure stops money flowing in from new investors, or out to departing ones, from inflating the number.

Say you hold a $100,000 portfolio. During the year you sell $30,000 of shares and use the money to buy $30,000 of other shares. Purchases and sales are both $30,000, so turnover is $30,000 divided by $100,000, which is 30%. Now suppose every trade costs a hypothetical 0.2% in commissions and spreads. The spread is the gap between the price buyers pay and the price sellers receive. The $30,000 sale costs $60 and the $30,000 purchase costs another $60, so the year's trading costs $120, or 0.12% of the portfolio. At 100% turnover the same arithmetic gives $200 on the sales plus $200 on the purchases. That is $400 a year, or 0.4%.

A common misunderstanding is that a fund's expense ratio, the annual fee shown in its documents, covers all of its costs. Trading costs from turnover are usually paid separately inside the fund. They show up only as slightly lower returns. Turnover also says nothing about why the trades happen. Some turnover is useful. Rebalancing, which means trading back to a target mix of assets, creates a little each year. Low turnover is not automatically a sign of quality, and high turnover is not automatically wasteful, but every trade has to earn back its cost.

For a private investor building a long-term portfolio, turnover matters because costs compound in the same way returns do. The annual fees of the large S&P 500 funds VOO, SPY and IVV are 0.03% to 0.09%. A few tenths of a percent lost to trading each year can therefore cost several times the visible fee. In taxable accounts, selling a holding that has risen usually creates a realised gain, which is a profit that becomes taxable once it is sold. Higher turnover can therefore also mean paying tax earlier. For these reasons, investors comparing funds or strategies often look at turnover alongside fees.

By Dr. Harry Hamann, MBA

What does a turnover of 100% mean?
It means the value of trades during the year equalled the portfolio's average size. On average, every holding was replaced once. It does not mean every single position was sold. Some may have been traded several times and others not at all.

What is a typical turnover for an index fund?
Broad index funds usually have low turnover, often in the single digits as a percentage. They trade mainly when the index changes its members or weights. Actively traded funds commonly report much higher figures, sometimes above 100%.

Does turnover affect taxes?
In taxable accounts it often does. Selling a holding that has gained in value usually creates a realised gain, which can be taxed in that year. Higher turnover tends to bring these gains forward, while low turnover lets more gains stay untaxed until a later sale.