Performance Drag

What Is Performance Drag?

Performance drag alludes to the difference between the return on an investment accepting there are no costs associated with it and the return on the investment in the wake of deducting costs associated with it.

The costs that cause performance drag and negatively influence the performance of an investment incorporate things, for example, paying taxes on investment returns, paying for transaction costs and fees connected with keeping an investment or account or potentially holding cash in a portfolio as opposed to investing the whole value of the portfolio. Performance drag is basically undeniable.

Understanding Performance Drag

For some traders, the genuine return of an asset is pointedly unique in relation to what might be recognized in the event that all transaction costs were taken out. This is due to the direct and indirect costs engaged with trading a security. Instances of direct costs for security trading are commissions and fees engaged with trading. Illustration of indirect costs for security trading are the opportunity costs to execute a trade as well as defers that would accompany the transaction.

A single method to relieve performance drag doesn't exist since it is caused due to different factors. Rather traders utilize investment strategies fit to their overall return objectives to limit performance drag. For instance, defers in executing a trading order probably won't be a critical factor for value investing. Be that as it may, it might mean the difference between a profit and loss for momentum trading.

Common Sources of Performance Drag

Commissions and other transaction costs: Performance drag is generally commonly credited to explicit brokerage commissions. Transaction costs additionally generally apply while utilizing an online trading platform. Outside of these explicit costs, there are numerous other implicit costs to trading, for example, timing, bid-ask spreads, and other opportunity costs that can make the return of an investment lag behind the return found in the market.
Advisor fees, expense ratios, and account maintenance fees: There are a large group of fees associated with keeping an investment account. Advisor fees must be paid while hiring an advisor to deal with 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 keep up with client accounts.
Cash: "Cash drag" is a common source of performance drag in a portfolio. It alludes to holding a portion of a portfolio in cash as opposed to investing this portion in the market. Since cash normally has exceptionally low or even negative real returns subsequent to considering the effects of inflation, most portfolios would earn a better return by investing all cash in the market. Nonetheless, a few investors choose 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 extra source of performance drag.

Illustration of Performance Drag

We should expect 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 they can recuperate the commissions paid to do the trades (a $0.60 rise on 100 shares will rise to the $60 that the investor needs to recover the commissions. $0.60 is equivalent to 2.5% of the $24 purchase price). The 2.5% cost of the transaction will make the investor's total return drag behind the change in the price of the asset, bringing about performance drag.

Features

The costs that cause performance drag can be direct or indirect.
A single method to moderate performance drag doesn't exist.
Performance drag is the difference between returns for an investment with associated trading costs and returns for an investment without associated trading costs.