A fund's turnover rate represents the percentage of a fund's holdings that have changed over the past year, and it gives an idea of how long a manager holds on to a stock. Fund accountants calculate a fund's turnover rate by dividing its total sales or purchases (excluding cash), whichever is less, by its average monthly assets during the year. You can translate this math easily: A fund that trades 25% of its portfolio each year holds a stock for four years, on average.
Despite its seeming simplicity, turnover rates have their quirks. For instance, a dramatic change in the fund's asset base (the turnover ratio's denominator) can give a false impression of a fund's trading activity. If the manager doesn't change her trading pace, a fund's turnover ratio will decline as assets rise. Conversely, a shrinking asset base can inflate a fund's turnover ratio.
Turnover can give you a sense of a manager's trading activity, but don't read too much into a fund's turnover rate, particularly with bond funds. In general, buy-and-hold managers will have lower turnover rates than managers who trade on short-term factors. And generally, very high-turnover managers tend to practice aggressive strategies. With bond funds, though, quite often managers employ cash-management strategies that inflate turnover rates. It's not uncommon to see turnover rates of 300% or more, even in funds that aren't particularly aggressive.