Glossary term
Fee drag
Definition
The compounding gap between a gross classroom path and the same path after costs. Small annual gaps become large stories over time.
How it works
Fee drag is the gap between a gross path and the same path after costs. A fee is subtracted from the compounding rate, and compounding is multiplicative, so the gap does not stay proportional: it widens, and widens faster the longer it runs. No unusually bad year is required; time alone is enough.
The useful comparison is not the fee against the return but the fee against the accumulated gain. A cost of 1% looks like one seventh of an assumed 7% return, but the total gain over thirty years is far larger than the fee's apparent share suggests. Fees scale with how much you hold and for how long; spreads scale with how often you trade; taxes depend on when gains are realized.
Worked example
Start with $100,000 and an assumed 7% gross annual return for 30 years. With no cost it grows to 100,000 × 1.07³⁰ = $761,226, a gain of $661,226. With a 1% annual cost the rate compounds at 6%, reaching 100,000 × 1.06³⁰ = $574,349.
The difference is $186,876, which is 28.3% of the $661,226 gain, not 1% and not one seventh. At a 2% cost the book reaches $432,194, and the fee takes about 49.8% of the gain. These are arithmetic on assumed returns, not predictions, and the same fee takes a larger share when the assumed gross return is lower.
Hypothetical, for education only. Not a recommendation and not a prediction.
Common mistake
The mistake is quoting a fee as a small percentage and stopping there. Measured against the return it sounds minor; measured against the gain that compounding would otherwise have produced, it is often a large fraction. A cost is also a number you can know in advance, while a return is only an assumption, so attention spent finding out what you actually pay is rarely wasted.