Cash drag as applied to a mutual fund, is a diminution of return caused by holding a cash position. A mutual fund typically holds a cash position to facilitate redemptions and pending investments. Since underlying securities of a mutual fund, especially stocks, often have better long-term returns than cash, a permanent cash position tends to reduce the performance of the fund. Cash drag is more pronounced among actively managed funds, which typically hold higher cash reserves than index funds, which usually remain fully invested.
John Bogle, in his article, The Arithmetic of ‘All-In’ Investment Expenses, published in the Financial Analysts Journal estimates that, on average, active stock fund cash holdings reduce active fund returns by 15 basis points a year.[note 1]
Monthly reporting of mutual fund cash positions are posted at ICI: Trends in Mutual Fund Investing .
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- The Bogle cash drag estimate assumes a 5% long-term active stock fund cash holding, a 6% long-term equity premium over cash returns. This results in a 30 basis point cost. Bogle assumes that many large active funds will partially equitize the fund's cash position through the use of stock index futures or exchange-traded funds. Thus, he cuts his estimate of cost by half, resulting in an estimated 15 basis point annual cost.