Portfolio turnover is the rate at which securities are bought and sold by a fund manager over a certain amount of time. It gives investors insight into the potential amount of activity and associated fees a fund might have. It can also be a helpful piece of data when examining and managing your personal portfolio. 

There are a lot of factors that can influence how high or low a turnover rate is, and learning about them can help you make better choices. We are going to go over the main elements that affect portfolio turnover so you can apply them to your investment analysis.

1. Investment Strategy and Objectives

An active investment strategy aims to beat the market’s performance and generate high returns by fervently watching, researching, and trading on a dime. The buying and selling that comes with active investing results in a high portfolio turnover rate.

A passive investment strategy focuses on prospering long-term and mimicking market indices rather than trying to outperform them. With this slow and steady approach, investors hold onto securities, and in turn, the portfolio’s turnover is lower.

2. Market Conditions and Volatility 

A volatile market fluctuates rapidly, with frequent, drastic high and low swings. In this condition, it’s common for investors to reallocate their funds or sell securities where necessary to mitigate risk. In turn, market volatility can cause portfolio turnover to be higher than usual.

3. Security Selection and Research 

An investor that takes the time to research is more likely to identify potential opportunities and risks. That knowledge can help them make better decisions and avoid having to make adjustments down the road. The less modifying an investor does to their portfolio, the lower the turnover rate will be. 

Conversely, someone that makes investment choices without doing enough research may be buying and selling later to reconcile their mistakes.

4. Investment Time Horizon 

An investor’s time horizon is how long they plan on holding onto an investment according to their goals, and it can impact portfolio turnover. 

Those with short-term goals (five years or less) frequently invest in low-volatility options like bonds. Since many of these short-term bonds mature in one year, they can actually cause a high turnover rate. 

Investors with long-term goals will buy assets intending to hold onto them for ten years or more. Although they may invest in more volatile options like stocks, they have more time to rebound from any potential losses. This long-term set-it-and-forget-it approach will yield a lower portfolio turnover rate.

5. Rebalancing and Portfolio Maintenance 

Regularly assessing your portfolio and ensuring it’s still aligned with your goals is crucial. Sometimes that means you will find areas where it needs to be rebalanced. 

Long-term investors won’t need to reallocate their assets as much. Although short-term may find themselves having to make adjustments more frequently, over-calibrating can result in excessive portfolio turnover. Whatever your goal is, it’s important to find a healthy balance. 

6. Liquidity and Trading Costs 

Liquid assets let investors trade easier and more efficiently due to their high number of buyers and sellers and lower trading costs. That allows them to manage their portfolios effectively and make fewer large adjustments meaning lower turnover rates.

On the other hand, non-liquid assets are more difficult to move and can have significant price fluctuations when trading. Although investors may not buy and sell these as often, the adjustments they do have to make are bigger, resulting in a greater impact on the portfolio turnover.

7. Risk Management and Position Sizing 

Risk management is a key part of maintaining your portfolio’s health. Finding an equilibrium between risk and reward can help mitigate unnecessary trading.

By monitoring your portfolio, you can ensure your asset allocation aligns with your risk tolerance. A diverse and well-balanced portfolio won’t need repeated adjustments, and the turnover rate will reflect that.  

Position size can also contribute to a higher or lower portfolio turnover. Some investors buy a random amount of an asset without using any strategy. When you consider your stop level and the amount you’re willing to risk on each trade, you can determine the appropriate position size. That will help reduce adjustments and portfolio turnover in the long run.

   8. Regulatory and Compliance Requirements 

Governments and regulatory authorities have rules and constraints you have to consider when investing.

Certain types of investments may have a required holding period, which can impact when you buy and sell them. The fees and costs that regulatory bodies establish can also affect how frequently investors trade, as well as regulations on insider trading and short sales. 

   9. Technology and Trading Infrastructure 

Technology has played a pivotal role in the investing world. With direct access to markets, trading, and portfolio management it’s also impacted turnover.

One of the ways it’s had an effect is through the ability to automate trade. Trading automation allows investors to buy and sell automatically within a predetermined set of parameters (or algorithms). This type of system can also track the market and adjust positions. Since it’s an automated process, it removes the potential for emotional decision-making and optimizes trading strategy. That, in turn, reduces portfolio turnover.

Tracking Your Portfolio Turnover for Performance Evaluation

There are several ways to evaluate portfolio turnover besides looking at the ratio. Let’s take a look at some of the most popular ones.

Holding Period Analysis

Holding period analysis looks at the average amount of time that the assets in your portfolio are held. The average is calculated by taking the total holding duration of all your securities and dividing that by the number of them in your portfolio. That number will give you an overview of the rate at which you sell, which is directly correlated to your turnover.

Performance Attribution Analysis

This type of evaluation looks at the turnover rate compared to the portfolio’s performance. It looks at asset allocation, the types of securities selected, and trading activity against the returns to determine if the choices that were made benefited or impaired the portfolio. 

Comparisons

By simply comparing your turnover rate against relevant benchmarks or peer groups, you can get a better idea of where your portfolio’s performance stands. You can also weigh other data, such as your holding period average. Comparisons help you to see if your rate is within normal ranges and if you need to reassess your actions.

Limitations and Considerations 

There’s nothing inherently wrong with having a high turnover rate as long as you have the returns to support your investment strategy. However, a high turnover rate can come with a few drawbacks. 

Trading frequently has associated costs such as brokerage fees and taxes which can begin to add up quickly and cut into your returns. If your turnover rate is high and your capital gains aren’t enough to rationalize the fees and taxes, it may be time to switch up your strategy.

Besides the monetary side of things, portfolios with a high turnover rate demand more management, time, and research. With short-term trading, there can be more margin for error, and adjustments may be necessary. With that comes a tendency to succumb to emotional decision-making. 

Just because you have a high turnover rate does not mean that you are falling victim to these factors, but it’s important to consider the costs, time, and potential stress.

Best Practices for Managing Portfolio Turnover 

To optimize your portfolio turnover, try implementing the following practices. 

1. Start by determining your investment goals. Are you focused on the short-term or long-term, and what is your risk tolerance? From there, you can get a clear picture of what investment strategy works for you and what your portfolio turnover should look like.
2. Do a ton of research on all of your investment decisions, and don’t make last-minute ones so you won’t have to fix your mistakes later.
3. Consider the transaction costs that come with trading. Assess how they affect your portfolio and try to keep them to a minimum where possible.
4. Monitor your asset allocation. Ensure it aligns with your goals and risk tolerance every few months. 
5. Track and analyze your portfolio’s performance. Use software with charts, benchmarks, and other comparison tools to assess your journey and see how it relates to your portfolio turnover.
6. Consult a professional, especially when in doubt about an investment decision. 

Conclusion 

Your portfolio turnover rate is one indicator that can help you get an overview of your portfolio’s performance. Consider all the factors that can influence turnover and incorporate them into your analysis. Always do your research when making investment decisions and consult a professional when you feel like you need advice.