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A portfolio turnover is an assessment of how often assets within a given portfolio are bought and sold. Measuring the rate of this type of turnover can often yield valuable clues regarding the amount of expense an investor is incurring with their trading activity, and compare that expense to the return generated by those trades. Calculating a portfolio turnover is usually done for a twelve-month period, although the basic process can also be used to assess the turnover rate for a quarter or semi-annual time frame.
In order to determine portfolio turnover, the value of the securities that are bought or sold during the period under consideration is calculated. That figure is then divided by the total net asset value of the portfolio during that same period of time. If the total net asset value for the current period is higher than the previous period, then the turnover is considered minimal. Should the value be lower than the previous period, that is an indication that expenses related to the portfolio were higher, did not yield sufficient return to offset those expenses and generated a higher turnover rate.
For example, if an investor purchases three investments during the course of the year while selling one security, the sale would be subtracted from the amount of the purchase, allowing for any trading fees or costs paid to brokers or dealers. This figure is divided by the current value of the portfolio. Should the three acquired investments fail to contribute to the value of the portfolio as effectively as the one security that was sold, this will show as a loss, or a decrease to the overall value of the portfolio and indicate an unacceptable turnover rate. In the event that the purchases did completely offset the sale, and those securities performed significantly better than the security that was sold, the portfolio turnover will be low and thus very favorable for the investor.
Investors can also undermine the value of the portfolio by making frequent trades that fail to yield a reasonable return, and help offset various fees and costs. For this reason, it is important to project the outcome of any transaction, in terms of its ability to earn a return. Just as in employee situations, a high turnover indicates the presence of issues that need to be addressed, a high portfolio turnover is a sign that the investor needs to look closely at how selects securities for purchase or sale, and adjust that process so the turnover rate is more beneficial.
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