The Turnover Ratio is the percentage of the fund’s holdings that have been sold and replaced with other holdings during the course of the year. A fund with a higher turnover ratio purchases and sells more stocks, bonds, and other financial instruments. The more transactions that a fund engages in, the more fees it incurs.
The turnover ratio is indicative of a fund manager’s investment philosophy. A fund with a high turnover ratio is more likely to be actively managed by a manager who believes he can beat the market. Because using speculation to manage funds is considered a poor investment philosophy, it’s wise to be wary of these funds.
Conversely, a fund with a low turnover rate incurs fewer transaction fees and is more likely to be operated by a fund manager tracking the market. Funds with a low turnover rates also offer significant tax savings. That’s because every time a fund manager sells a stock or bond, he must report the money earned as a taxable gain. These capital gains can be passed on to the fund’s shareholders through higher fees.