Imagine starting your investment journey with $10,000 in your pocket. You’re 25 years old, just beginning your career, and you decide to systematically save money for the future. You choose the classic 60/40 portfolio (60% S&P 500, 40% US bonds) – a popular and “lazy” passive strategy where you only buy assets when making contributions, occasionally rebalance, and potentially withdraw money when you need it. No market predictions, no active trading – just a simple but effective strategy. This is just an example (personally, we prefer a global equity basket), but it’s very instructive.
After 30 years, you want to check how much capital you’ve accumulated. Will it be a solid sum, or perhaps… significantly less than it could have been? The answer might surprise you, because everything depends on one thing – costs that seem innocent but can “devour” a real fortune.
The Enemies of Your Portfolio: What Costs Await Investors?
Every beginning investor quickly discovers that the financial world isn’t free. Three “opponents” await them:
- Transaction Costs. These are commissions charged by brokers for every purchase and sale. They seem small, usually fractions of a percent, but when you buy and sell regularly, they can quickly add up. Besides broker commissions, other costs may appear like spreads (the difference between buy and sell prices) or currency costs when investing in foreign assets. In the case of a passive portfolio we’re discussing here, they’re not the biggest threat – you essentially only execute transactions when adding funds or withdrawing from the portfolio, plus during rebalancing. By nature, such a portfolio generates few transactions.
- Management Fees. These are fees charged by investment funds and ETFs for their services. It’s a percentage of your investment value, charged continuously, regardless of whether the fund makes or loses money. The fee is automatically deducted from the fund’s unit value, so you usually don’t even notice it. It works like an “invisible hand” that systematically takes part of your money.
- Tax Costs. Capital gains tax, which you pay every time you sell something at a profit. These don’t have to occur everywhere and always – in many countries there are retirement investment opportunities with various tax advantages. However, for educational purposes here, we’ll show how enormous the impact of taxes can be on the final result.
All these costs may seem harmless, but in the long term, they can turn your investment journey into a real drama.
The Story of Four Portfolios: A Million-Dollar Experiment
To show how dramatic the impact of costs can be, a simulation was conducted using System Trader software. For educational simplicity, we examined the classic 60/40 portfolio (60% S&P 500 stocks, 40% US ten-year bonds) investing for 30 years, from 1995 to 2024.
The assumptions were simple: The investor starts with $10,000, then adds $3,000 quarterly plus inflation adjustment (so this amount maintains constant purchasing power over time). The portfolio was regularly rebalanced – if the share of stocks or bonds deviated by more than 20% from the assumed proportions, the investor performed rebalancing. Each new contribution was used to maintain proper 60/40 proportions to minimize the need for “manual” portfolio rebalancing.
Of course, this is a simplified model with many assumptions – in reality, every situation is different and it’s always worth carefully calculating everything for your specific situation (different portfolio, different amounts, different period, etc.). But the main message about costs remains relevant.
And now the real story begins…
Portfolio One: “Perfect World”
In a dream world without any costs, our investor after 30 years has exactly $2,041,618 in their account. That’s over $2 million! Sounds great, but it’s only theory, because such a perfect world is hard to find in reality.
Portfolio Two: “Transaction Cost Reality”
In the real world, transaction costs will always exist – even if not in the form of brokerage commissions, then for example spreads. Here we assumed a cost of 0.3% for each purchase or sale transaction – a value arbitrarily chosen for this example’s purposes. This is rather a high cost; today you can find much cheaper brokers and very liquid ETFs. But something had to be assumed to show the impact of such costs.
For a complete picture, two portfolio values after 30 years are provided:
- Gross amount ($2,032,306) is the effect of only costs incurred ongoing for 30 years, without additional commission on portfolio liquidation (so we have commissions paid when buying ETFs with new funds and from transactions resulting from portfolio rebalancing). This is a realistic scenario – an investor most often consumes the portfolio over years, not withdrawing everything in one day, so these costs are spread over time. In this case, commissions paid after 30 years were $9,312, or 0.46% of portfolio value.
- Net amount ($2,026,209) is the portfolio value assuming that after 30 years the investor sells the entire portfolio at once, paying an additional commission on the full amount in the portfolio. This is an unrealistic variant, but shown for a complete picture. In this case, commissions paid after 30 years were $15,409, or 0.75% of portfolio value.
Portfolio Three: “Management Fee Trap”
Attention – here we have a completely different category of costs than with transaction commissions (even though we have 0.3% in both cases)! Management cost is 0.3% annually on the entire portfolio value, also arbitrarily chosen for educational purposes. In reality, you can find significantly cheaper ETF funds, even well below 0.1% annually. Seems innocent, right?
After 30 years, the portfolio is worth $1,921,524. That’s already $120,094 less than in the ideal world without costs – a difference of almost 6%! It’s worth noting that this is still a small cost, because there are funds costing even 5-10 times more…
Portfolio Four: “Tax Nightmare”
In this part of the analysis, we focus on the impact of capital gains taxes (here we assumed a 19% rate – just an example, as different rules or exemptions may apply in different countries). Similarly to commissions, we provide two variants in the table:
- Gross amount ($1,965,602) shows the effect of ongoing tax costs for 30 years, assuming the investor doesn’t liquidate the entire portfolio at once at the end. This means taxes are calculated gradually on transactions related to rebalancing, but there’s no one-time settlement of all gains at the end. This approach corresponds to typical investor behavior, who uses the portfolio for years instead of consuming it in one day. In this situation, the total value of taxes paid after 30 years was $76,016, or 3.72% of the final portfolio value.
- Net amount ($1,730,585) assumes that after 30 years the investor decides to sell the entire portfolio at once – and settle tax on the entire realized profit in one transaction. This variant is rarely seen in practice, because usually a portfolio built over years is also consumed over years, but for a complete picture we also show this scenario. Then the total value of taxes paid after 30 years increases to $311,033, or 15.23% of the final portfolio value.
What If We Don’t Rebalance?
Then we actually limit both transaction and tax costs, which might seem like a smart strategy. But it’s worth considering why we chose a 60/40 portfolio in the first place – it’s about having bonds moderate the volatility of the whole, even at the cost of lower returns. If we completely gave up standard rebalancing and instead only tried to restore balance by directing new contributions toward underweighted assets, this would work only within the limits of those fresh funds. Over time, as the portfolio grows, these new contributions might not be enough to bring the allocations back to target weights. In this specific example, after 30 years we’d end up with a 73/27 portfolio instead of the intended 60/40 – meaning stocks took over the portfolio.
Someone might say: What’s wrong with that?!
The problem is that the risk level increases not when the young investor starts, but just before retirement (i.e., at the moment when capital security matters most). First, over those years you could have had a larger portfolio (if you had chosen higher equity exposure from the beginning). Second – on the eve of retirement, the risk of the so-called sequence of events increases, i.e., a stock market decline just before transitioning to the capital consumption phase, which could reduce the value of the equity portion by even 50% or more. Rebalancing is therefore not only a cost control tool, but above all protection against undesirable risk increases, especially before key investment decisions.
The Moral of the Story: What to Really Pay Attention To
This story reveals several important conclusions that can change the way you think about investing.
- First: Brokerage commissions are the smallest problem for a “lazy” passive portfolio – completely different from active trading, where frequent transactions can consume a significant portion of profits. For a passive investor, even multi-year commission costs are just a fraction of a percent of portfolio value – most often below 1% after decades of investing. In practice, broker reliability and basic transaction security are more important than small differences in commissions.
- Second: Management fees are the “silent killer” of portfolios. Seemingly innocent 0.3% annually on the entire portfolio translates to over $120,000 “eaten” by financial institutions in the long term, or almost 6% of the final portfolio value (in this example, the final result is $1,921,524 instead of over $2 million). And we’re talking about a cheap product. However, if you choose a fund with a fee of, for example, 2%, such a cost can consume even half or more of your wealth over 30-40 years! That’s why it’s always worth consciously choosing the cheapest ETFs. The market has investment products with very low management costs – the cheapest ETFs on global indices or S&P 500 can cost even 0.03-0.07% annually (there are even ETFs with 0% cost!). However, remember that not every market segment or strategy can be so cheap: ETFs on niche markets, commodities, or active strategies often have fees of 0.5-1% or even more.
- Third: Taxes are a huge enemy of long-term investors. Tax costs can “eat” from several to several dozen percent of capital. Alongside management costs, this is the second most important area for optimization. It’s worth using retirement accounts and tax advantages wherever possible. It’s like a free lunch!
The most important lesson: In long-term investing, what matters is how much money stays in your pocket after accounting for all costs. Control primarily management fees and taxes, because here you have real impact on the result. Don’t focus too much on transaction costs if you use a lazy portfolio – here broker credibility matters. Self-discipline is also important – you need to stick to the strategy and not try to “control” the market, because this most often leads to worse results.
Finally, remember that 30 years in this example isn’t as much as it seems – a young person starting to invest at age 20-30 can build a portfolio for three decades, then consume it for another 30 years. So the portfolio can “live” for over half a century! What seems like a small cost today will grow over decades to enormous amounts that can determine your financial situation.
Conclusion
The hidden costs of investing – transaction fees, management expenses, and taxes – can significantly erode your long-term wealth. While transaction costs are relatively minor for passive investors, management fees and taxes can consume substantial portions of your portfolio over time. The key is to:
- Choose low-cost ETFs / index funds with expense ratios well below 0.5%
- Optimize for tax efficiency using retirement accounts when possible
- Maintain discipline with a simple, consistent investment strategy
- Focus on what you can control – costs and behavior, not market timing
Remember: small percentages compound into large dollar amounts over decades. Being mindful of these hidden costs today can mean the difference between a comfortable retirement and financial struggle tomorrow.
By Jack Lempart
P.S. If you’d like to analyze your investment portfolio, try our free tool: Passive Portfolio Simulator.
