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 the difference between returns for an investment with associated trading costs and returns for an investment without associated trading costs. 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. 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.
What Is 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.
Understanding 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. This is due to the direct and indirect costs involved in trading a security. Examples of direct costs for security trading are commissions and fees involved in trading. Example of indirect costs for security trading are the opportunity costs to implement a trade as well as delays that might accompany the transaction.
A single method to mitigate performance drag does not exist because it is caused due to a variety of factors. Instead traders employ investment strategies suited to their overall return goals in order to minimize performance drag. For example, delays in implementing a trading order might not be a significant factor for value investing. But it may mean the difference between a profit and loss for momentum trading.
Common Sources of Performance Drag
Example of Performance Drag
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 they 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.
Related terms:
Brokerage Window
A brokerage window is a 401k plan option that gives the investor the capability to buy and sell investment securities through a brokerage platform. read more
Cash Position
A cash position represents the amount of cash that a company, investment fund or bank has on its books at a specific point in time. read more
Commission
A commission, in financial services, is the money charged by an investment advisor for giving advice and making transactions for a client. read more
Dead Money
Dead money is a slang term for an investment that has failed to show any significant growth in value or substantial return for a protracted period. read more
Exchange Traded Fund (ETF) and Overview
An exchange traded fund (ETF) is a basket of securities that tracks an underlying index. ETFs can contain investments such as stocks and bonds. read more
The of Expense Ratio
The expense ratio (ER), also sometimes known as the management expense ratio (MER), measures how much of a fund's assets are used for administrative and other operating expenses. read more
Explicit Cost
Explicit costs are normal business expenses that appear in the general ledger and directly affect a company's profitability. read more
Frictionless Market
A frictionless market is a theoretical trading environment where all costs and restraints associated with transactions are non-existent. read more
Implicit Cost
An implicit cost—also called imputed, implied, or notional costs—are any cost that has already occurred but not necessarily shown or reported as a separate expense. read more