- The difference between the return on investment (without deducting cost) and return on an investment after deducting cost is termed as performance drag.
- The cash drag is the standard type of performance drag, which is caused when a portion of cash from the portfolio is withheld and is not invested.
Performance drag refers to the reduction in earnings on a portfolio due to factors other than market performance.
The reasons for a performance drag include costs, fees, and taxes, which erode the principal sum that is put to work. They drag down the ability to maximize returns and hence, cause a performance drag.
About Performance drag
While investing, we expect a certain amount/percentage on the return of the investment. But what we actually get is less. The difference between the return on investment (without deducting cost) and return on an investment after deducting cost is termed as performance drag.
The deduction of this cost causes the performance to drop in charts, and hence it is called performance drag. This negative effect on performance is due to
- Taxes on investment returns- taxes are collected by the government and are an additional source of the performance drag.
- Transaction cost – performance drag is mostly attributed to the commission or brokerage fees that a trader or broker may charge for the transaction. Also, while performing a transaction, a company has to pay for charges on the transaction, and that too is taken out of the return on investment.
- Maintenance fee of an investment/ account- while maintaining a portfolio or account with an investment institution, the institution has to maintain your account and perform transactions on your behalf. Due to this, the customer is charged for advising and maintaining their account. The fee hence is taken out of the returns on investment.
This drop in performance hence is unavoidable.
Cash drag: – cash drag is the standard type of performance drag, which is caused when a portion of cash from the portfolio is withheld and is not invested. Cash typically has a zero or negative return (due to inflation). Generally, it is considered that we could earn more if we invest all money in the market. Still, some investors decide to hold cash as an emergency fund or for diversification activity.
Example of Performance Drag
At a starting price of Rs. 40/share, let’s imagine an investor spends Rs. 25 in brokerage costs to purchase 100 shares of XYZ Company, and another Rs. 25 to sell those shares. In this instance, the investor needs a 1.25% increase in the stock price in order to recover the commissions he/she paid to execute the trades. 1.25% of the Rs. 40 buying price is Rs. 0.50. The 1.25% 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.