On average fund managers have between 3% and 7% of cash on hand for buying opportunities and redemptions. Let me ask you – what is the ROR of the cash in your bank account? 0%. This is dead money, because cash earns no return. Essentially, buy and hold investors are subsidizing other investors’ liquidity needs. Hence mutual funds are not very efficient.
To get a better idea of how much money we are talking about – Lets take a look at the Fidelity Contrafund which is worth about $111 BN. In 2016 the fund had 4.23% sitting in cash for redemptions. While 4% doesn’t sound like a lot – that equates to $4.7 BN in cash earning a 0% rate of return.
According to a study by William O’Rielly, CFA, and Michael Preisano, CFA, the average cost from cash drag on large cap stock mutual funds over a 10-year time horizon was .83% per year. This cost results from investors paying the mutual fund’s expense ratio on 100% of the money invested despite the fact that not all of the assets are invested in stocks or other securities. This cost also must factor in a lost opportunity cost (LOC) because the money sitting in cash never earns a rate of return. Essentially you are paying for cash to be held in the mutual fund.
Cash drag can have a major impact on your ability to earn the returns you want and expect from a mutual fund.