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by Jonathan AnthonyUnderstanding Portfolio Turnover and How to Calculate It
When it comes to analyzing your portfolio, the more angles you can get on the situation, the better. Portfolio turnover breaks down the dollar amount of securities you bought and sold compared to your assets’ value and presents it in a tidy percentage.
So how do you come up with this number, and what does it mean? We are going to show you exactly how to understand portfolio turnover so you can add this new metric to your analysis repertoire.
While it may seem obvious, since you’re the one doing the investing, sometimes the actual data may surprise you.
What is Portfolio Turnover?
Portfolio turnover is the rate at which fund managers buy and sell securities in a fund over a specific amount of time.
Many investors look for a low ratio when shopping for a managed fund since it generally means lower fees and operating costs. However, an active investing strategy that results in greater returns can compensate for the pitfalls of a high turnover rate.
This calculation can also be helpful when applied to your personal investment portfolio.
How to Calculate Portfolio Turnover
To calculate portfolio turnover, you can use a simple formula, but first, you need to know a few variables from the last 12 months.
The formula is the minimum total dollars bought or sold divided by the average monthly portfolio value times 100, so it displays as a percentage.
The numbers get crunched regularly to tell a fund manager’s story and see if their investment strategy shifts over a particular period. When applied to your personal investment journey, it can be a good way to gain insight into your portfolio’s performance.
Annual Portfolio Turnover Rate Formula & Example
To make things easy, let’s think of it in terms of X / Y = Z, where Z*100 is the turnover rate.
See, we told you it’s simple, so now let’s figure out X and Y.
X is the minimum of securities bought or sold throughout the year.
Example: You bought $20,000 worth of stocks last year and sold $15,000. X equals $15,000 (the smaller number of the two).
Y is the average monthly value of your portfolio over the year. To get this variable, you can go back in your portfolio reports to see its value at the start of each month, add those together, and divide by 12 months.
For this example, let’s look at a made-up portfolio:
| Month | Portfolio Value |
|---|---|
| Jan | $120,000 |
| Feb | $140,000 |
| Mar | $110,000 |
| Apr | $90,000 |
| May | $115,000 |
| Jun | $115,000 |
| Jul | $125,000 |
| Aug | $145,000 |
| Sep | $105,000 |
| Oct | $100,000 |
| Nov | $95,000 |
| Dec | $100,000 |
The total of all months added together is $1,360,000. Divide that by 12 months, and you get a $113,333 average monthly value. Y equals $113,333.
Now that we have X and Y calculating Z is just a simple division. $15,000 / $113,333 = 0.132.
Finally, we multiply that number by 100 to get a 13.2% Portfolio Turnover Rate.
Factors Affecting Portfolio Turnover
There are several factors that dictate how often you buy, hold, sell, or pivot along your investing journey, and they all affect your turnover rate. Let’s take a look at the most common occurrences below.
Investment Strategy (Active vs. Passive)
Your investment strategy directly affects your portfolio’s turnover ratio.
Active investors taking an aggressive approach will likely have higher turnover ratios as they buy and sell securities frequently.
Passive investors follow more of a “buy and hold” strategy and therefore have naturally lower turnover percentages.
Passive strategies can be nearly “set it and forget it.” On the other hand, buying and selling more often (i.e., increasing your turnover ratio) takes additional planning, tracking, and effort but can pay off when done right.
The route you choose depends on your style.
Investment Horizon (Short-Term vs. Long-Term)
The types of securities you invest in will depend on a few factors, one of the main ones being your time horizon.
Those with a short time horizon are looking to gain a return on their investments in 5 years or less. They will typically set realistic goals and invest in low-volatility assets, like bonds, for example.
Despite their mostly fixed rate of return, many bonds are short-term in nature, which can yield a higher portfolio turnover ratio.
You might buy bonds that mature in 1 year, sell them and repeat the process again the following year. You’re taking less risk but possibly buying and selling the securities more often.
Investors with long-term goals typically focus on assets they’ll hold on to for ten years or longer. That’s because they can afford to invest in more volatile options like stocks since they will have more time to bounce back if the market dips.
The goal here is to buy securities and let them ride, which means the turnover ratio is lower in the long run.
Market Conditions (Volatility, Trends, etc.)
Regardless of your investing strategy, market trends can throw a wrench into the plan and affect your portfolio turnover ratio.
A stable market can make investors more comfortable with buying and selling, while a volatile market can put trading on pause.
For example, if the market drops 15%, you may go into a holding pattern while you wait for things to recoup.
Selling off at that specific moment to buy another security would lock in your losses. In times like these, you’ll see lower turnover ratios in your portfolio.
Fund Manager’s Style and Objectives
Fund managers all have different styles and usually several funds to choose from based on how you would like to have your money handled.
Similarly to the tactics we mentioned above, they can be passive or active, focus on different timelines, and attack market conditions in varying ways.
When choosing where to put your money, we suggest looking at their past performance and using averages or benchmarks to see how a specific fund performed historically.
Implications of High and Low Portfolio Turnover
Based on the factors above, varying portfolio rates can be the result of an investor’s actions or things that happen in the market during the analysis period.
While it’s not always cut and dry, let’s look at some of the pros and cons of high or low ratios.
Pros and Cons of High Portfolio Turnover
| Pros | Cons |
|---|---|
| A portfolio with high turnover indicates the investor is taking an active approach. That could mean things are more hands-on. | Increased expenses and fees on selling or buying can reduce the portfolio’s overall performance. |
| High turnover can mean short-term investments are locking in wins. | Sells lock in profits, so Incurred capital gains taxes can be higher. |
| Frequent pivots give you the flexibility to follow market trends. | High turnover means more buying and selling, which can be stressful for some. |
Pros and Cons of Low Portfolio Turnover
| Pros | Cons |
|---|---|
| Low turnover means lower associated costs and fees since fewer moves occur. | Since low turnover is associated with long-term investing, you can feel limited or locked in. |
| A set-it-and-forget-it portfolio is less stressful as it requires less diligence. | There is usually less excitement associated with a portfolio that has lower turnover. |
| You can delay capital gains taxes until you sell, so you aren’t incurring them as frequently. | Holding securities means you need to be able to stomach market dips as years go on. |
Figure Out Your Portfolio Turnover Today
Portfolio turnover rates tell the story of how your investments are managed. This number is essentially the result of actions you’ve taken over the year. So, if you want a better understanding of your investment strategy narrative, try evaluating your ratio.
One of the easiest ways to calculate everything is to figure out your formula variables with a portfolio tracker like StockMarketEye.
Our powerful but easy-to-use tools help you gain deep insight into your buying and selling patterns. Sign up for our free trial today and import your information to see exactly how accurate reports can help you become a better investor.
