What is a Performance Drag?

Performance drag is a term used to describe the impact that various sorts of transaction fees and associated costs have on the overall performance of an investment. The idea is to find ways to seek the lowest cost structure possible, and thus minimize the amount of drag that is experienced. While just about any type of investment has some type of transaction costs or commissions attached to the purchase or sale, there are ways to keep those costs as low as possible, allowing the investor to realize more of a return than would be possible otherwise.

One of the main costs associated with performance drag is the commission paid to the brokerage that handles the transaction. There are two ways to contain this cost and thus lower the amount of drag. One approach is to work with a broker who charges a lower commission, either in the form of a flat rate or a percentage. A second approach has to do with the anticipated performance of the asset itself. For example, if the stock is anticipated to increase by five percent shortly after the acquisition, and the brokerage commission comes to four percent, the investor offsets the commission quickly and can move on to enjoying the return generated as the stock continues to rise.

Along with fees and commissions, there are other factors that may contribute to performance drag. A notable example is the difference between the bid price offered by the buyer and the ask price desired by the seller. A wider spread means a greater chance that the bidder will need to increase his or her bid in order to purchase the securities. The higher price means that it could take longer for the investor to recoup his or her initial investment before a profit is truly earned from the acquisition.

Assessing the performance drag is essential if the investor wants to truly gauge how much return is being earned from an investment. Since transaction fees, the spread between the bid and ask prices, and brokerage commissions are incurred as a result of acquiring the securities, these costs must be recouped before the investor truly begins to earn any type of profit. Keeping those costs as low as possible helps to hasten the generation of profit, and may be an excellent approach if the upturn with the securities is expected to be slow but steady. Even if the upturn is projected to be somewhat sudden and dramatic, effectively managing costs on the front end only makes it easier to cover the performance drag and begin realizing a return sooner rather than later.