How do fees and expenses impact long-term portfolio returns?

• A. They diversify risk across asset classes.
• B. They reduce compounded returns; higher costs require larger gross returns to achieve the same net result.
• C. They have no impact on long-term performance.
• D. They only affect taxes.

Answer: (B)

Fees and expenses act as an ongoing drag on portfolio growth. Because investment returns compound over time, any amount taken out as costs reduces not only the current year’s return but every future year’s basis on which that return is earned. When costs are higher, the net return after fees is smaller, so you have to achieve a larger gross return to land on the same net result. Over long horizons, even small annual fees can meaningfully erode wealth because the reduced net returns compound.

For a concrete sense of the effect, imagine $100 growing at 6% gross versus 5% net due to fees. After 30 years, the 6% path becomes about $574, while the 5% path ends around $432. That gap illustrates how costs squarely impact long-term performance.

Diversification distributes risk, but it doesn’t address the drag fees create. Fees don’t have to do with taxes; they’re direct reductions to returns. And fees do matter for long-term results, so the statement that they don’t is incorrect.