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In conversations with friends, they are often very surprised at the net difference between the total of two investments with identical positive returns, which can be attributed to different annual management fees.

While compound interest appreciation can still be explained to some extent, in particular by the well-known notion of compound interest itself, the negative impact of high management fees is not so easy to understand by most people.

For lack of better knowledge, I have often and falsely described this effect as kind of a negative compound interest rate. This is not correct and I wonder if there is a specific term for the increased impact of management fees on positive return investments, that describes this effect best and is easy to remember for a layperson?

Sebastian Zolg
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    It is almost exactly a negative interest rate. Thats basically spot on. Losing x% compounded over a specific period is exactly that... – Vality Jul 28 '19 at 19:53
  • Thank you - one can argue that in a scenario with a negative return investment, an annual management fee is not "as negative" for the investor, because it's going down. Many people see this attribute but can't see it, when the fee eats parts of the positive return. This is why I was searching for the other term. – Sebastian Zolg Jul 28 '19 at 20:05
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    You can run the numbers to figure out the real return. E.g. a 5% gross return and a 1% management fee give you (1.05 × 0.99) a 3.95% net return – and then use that for compounding calculations. – amon Jul 28 '19 at 21:03

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There are lots of general descriptions for the diminished return that you cite:

  • reduced return
  • impact of investment costs
  • impact of fees
  • reduced CAGR

John Bogle of Vanguard fame called it “the tyranny of compounding costs.”

The most specific financial terminology that I know of would be Performance Drag which is the difference between the return on an investment with no associated costs and the return on that investment after deducting any costs associated with it (commissions, margin borrowing, account fees, tax on dividends, etc.).

Bob Baerker
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