DEFINITION of 'Performance Drag'

Performance drag refers to the difference between the return on an investment assuming there are no costs associated with it and the return on the investment after deducting costs associated with it. The costs that cause performance drag and negatively affect the performance of an investment include items such as paying taxes on investment returns, paying for transaction costs and fees related to maintaining an investment or account and/or holding cash in a portfolio rather than investing the entire value of the portfolio. Performance drag is essentially unavoidable.

BREAKING DOWN 'Performance Drag'

For many traders, the actual return of an asset is sharply different than what would be recognized if all transaction costs were removed. For example, let's assume an investor pays $30 in brokerage commissions to buy 100 shares of ABC Company at an entry price of $24 per share and another $30 to sell those shares. In this case, the investor needs the stock's price to rise 2.5% so that he or she can recover the commissions paid to do the trades (a $0.60 rise on 100 shares will equal the $60 that the investor needs to recoup the commissions. $0.60 is equal to 2.5% of the $24 purchase price). The 2.5% cost of the transaction will cause the investor's total return to drag behind the change in the price of the asset, resulting in performance drag.

Common Sources of Performance Drag

Commissions and other transaction costs. Performance drag is most commonly attributed to explicit brokerage commissions, such as the $30 fee in the example above. Transaction costs also generally apply when using an online trading platform, such as TD Ameritrade. Outside of these explicit costs, there are many other implicit costs to trading, such as timing, bid-ask spreads and other opportunity costs that can cause the return of an investment to lag behind the return seen in the market.

Advisor fees, expense ratios and account maintenance fees. There are a host of fees associated with maintaining an investment account. Advisor fees must be paid when hiring an advisor to manage a portfolio. A management fee or expense ratio must be paid to the manager of the mutual fund, exchange traded fund or separately managed account holdings. Maintenance fees are paid to a custodian or bank to maintain client accounts.

Cash. "Cash drag" is a common source of performance drag in a portfolio. It refers to holding a portion of a portfolio in cash rather than investing this portion in the market. Because cash typically has very low or even negative real returns after considering the effects of inflation, most portfolios would earn a better return by investing all cash in the market. However, some investors decide to hold cash to pay for account fees and commissions, as an emergency fund or as a diversifier of other portfolio investments.

Taxes. Applicable taxes are an additional source of performance drag.

RELATED TERMS
  1. Tax Drag

    Tax drag refers to the loss of income due to owing taxes.
  2. Dividend Drag

    Dividend drag is the drag on a unit investment trust's (UIT) ...
  3. Fee

    A fee is a fixed price charged for a specific service and is ...
  4. Performance Fee

    A performance fee is a payment made to an investment manager ...
  5. Commission

    A commission is a service charge assessed by a broker or investment ...
  6. Investment Manager

    An investment manager is a person or organization that makes ...
Related Articles
  1. Investing

    Everything You Know About Investor Fees

    Investment fees are one of the main determinants of investment returns, and over time, minimizing fees tends to maximize performance. Use this guide today.
  2. Investing

    8 Investing Fees That You Should Never Pay

    In investment management and financial planning there are a plethora of fees that are unnecessary.
  3. Tech

    Are Financial Advisor Fees Too High?

    Fees charged by financial advisors run the gamut. Are you getting a fair deal or paying too much?
  4. Personal Finance

    Do You Know How Your Financial Advisor Is Paid?

    It is important to understand how your financial planner is compensated.
  5. Personal Finance

    How Your Financial Advisor Makes Money

    Do you know how much you are paying your advisor? There are two main ways they are compensated.
  6. Investing

    Investors: Your Fees Are Probably Too High

    The lower your fees, the higher your returns. Here's how to find out if you're paying too much for your investments.
  7. Investing

    Understanding Investment Fees Is Critical to Success

    Awareness of the different layers of investment fees can help you, as an investor, reduce the fees you're paying and increase your investments.
  8. Investing

    3 Investment Fees That Are Negotiable

    Investment fees are a necessary evil but that doesn't mean they have to be overly costly. There are ways to negotiate some of the expenses down.
  9. Investing

    Misconceptions About Past Performance And Future Returns

    Relying on an investment's past performance to guide your investment decisions is a losing strategy. Find out why.
  10. Personal Finance

    The Ins and Outs of Bank Fees

    These service charges could nickel-and-dime you right out of your nest egg.
Trading Center