One Percent Sounds Small. It Is Not.
Fees are charged on the balance, not the gains, which is why a rounding-error percentage becomes a life-changing number over a career.
The fee is on everything, every year
A 1.5% expense ratio does not take 1.5% of your gains. It takes 1.5% of your entire balance, annually, whether the fund made money or lost it. In a flat year you still pay. In a bad year you pay while losing.
Because the charge scales with the balance, it grows exactly as your portfolio grows — and the money removed would itself have compounded. That is the mechanism that turns a small percentage into the numbers above.
Net compounding
FV = Σ contributions × (1 + (R − TER)/12)ᵐ
- R = gross return, TER = total expense ratio
- The fee is subtracted BEFORE compounding, every period
- A 1.3pt gap on a 9% gross return removes about a seventh of the return, every year, forever
What the dearer fund has to do
The comparison here holds gross return identical, so the entire divergence is fees. That is the right way to frame the decision: a fund charging 1.3 percentage points more must beat the cheaper one by 1.3 points before costs, every single year, just to draw level.
It is not impossible. The evidence that it happens reliably, persistently, and identifiably in advance is weak — which is the actual argument for low-cost investing, rather than any claim that active management cannot work.
Fees you cannot see in the TER
The published expense ratio is not the whole cost. Portfolio turnover generates trading commissions and bid-ask spread, neither of which appears in the TER, and both of which are higher in actively-managed funds precisely because they trade more.
In taxable accounts, turnover also realises capital gains you would otherwise have deferred. The real gap is usually wider than the headline one.
Where entry loads still bite
A 3% entry load removes three percent of every contribution before it is invested, so it never compounds for you at all. Front-loaded charges have largely disappeared in some markets and persist in others; the calculator includes the option because where they exist they are worth seeing quantified.