Fee drag is the difference between the arithmetic people expect and the arithmetic that actually applies. A 1% annual fee over forty years does not cost 40% of one year’s return. It costs 1% of the balance every year, and it also costs all the growth those deductions would have produced.
That second part is the one that surprises people. Money removed in year three would have compounded for thirty-seven more years, so its true cost is many multiples of the amount taken.
We simulated 5,000 forty-year saving lifetimes at 0%, 0.5% and 1% fee drag. The dollar gap at the finish line is far larger than the percentage sounds, and it widens with the size of the portfolio and the length of the horizon — which is to say it is worst for exactly the people who invested the most and started the earliest.
The practical consequence is that fees deserve the same attention as asset allocation, and considerably more attention than most people give them, because the effect is certain rather than probabilistic.
Research on this
See also
- Expense ratio — The annual percentage a fund charges against assets to cover its own running costs, deducted from the fund’s value rather than billed to you.
- AUM fee — A fee charged as a percentage of the assets a manager oversees, typically 0.5% to 1% a year, billed regardless of whether the portfolio gained or lost.
- Volatility drag — The gap between the average of a series of returns and the compound growth actually achieved. Higher volatility widens the gap, even with an unchanged average.