Investment Fees, Expense Ratios, and the Average Return Illusion in Retirement

Investment fees and expense ratios quietly drain retirement savings every year, and the average return illusion makes your investments appear to perform better than they actually did. A fund that gained 50% one year and lost 50% the next advertises a 0% average return, but your portfolio actually lost 25% of its value. Understanding the difference between advertised average returns and compound annual growth rate (CAGR) is essential for accurately assessing what your money is actually doing for you, and for protecting the retirement income you have worked to build.

Why This Matters More Than Most Retirees Realize

Two forces quietly work against retirement portfolios that most investors never fully account for: fee drag and return distortion. Fee drag does double duty damage on your retirement. First, it reduces what your portfolio compounds to over time without ever showing up as a direct bill. Second, and probably more insidious for a majority of retirees, it reduces how much you can safely spend in traditional planning’s typical safe withdrawal rate, success score and guardrail strategies. Research from Michael Kitces found that a 1% increase in investment expenses reduces the safe withdrawal rate by about 0.4%, roughly 40% of the fee, so a 4% starting withdrawal rate becomes about 3.6%.¹

Return distortion makes your investment track record look better than it actually was, leading to income projections that are higher than what your money can realistically support.

Both forces compound over decades. A retiree who fails to understand how these are working against them in retirement may arrive at retirement with significantly less wealth than their statements suggested, and an income plan built on assumptions that never reflected reality. Understanding these forces is the foundation of successful retirement income planning.

Decades is the right word, and it is often more of them than people plan for. J.P. Morgan gives a non-smoking 65-year-old woman in excellent health a 54% chance of reaching 90 and a 30% chance of reaching 95, and for a couple the odds one of them reaches 95 are 44%.² The longer the run, the more both forces get to work, so start with how long you are likely to live.

The Average Return Illusion: What It Is and Why It Misleads

When investment funds advertise their performance, they typically report the arithmetic average return. This is calculated by adding up each year’s return and dividing by the number of years. It sounds straightforward, but it is mathematically misleading for understanding what actually happened to your money.

In order for an arithmetic average return of say 7.5% to really be true in retirement when you have a big balance in your retirement accounts AND those accounts are generating your retirement income, you would essentially have to get that 7.5% each and every year. And if you could actually get 7.5% every single year, couldn’t you then actually take out 7.5% of your portfolio each year, spend it all, and end up with the same balance at the end of retirement? Quick caveat to this ridiculous example. In order to actually end up with the same balance you began your retirement with, you would need to be paying your annual advisor fees out of the hypothetical income that a ridiculous situation of getting 7.5% every year in retirement would create. Emphasis on how ridiculous this hypothetical scenario has to be to make true what traditional planning tends to lead you to believe about your retirement.

Here is a simple example that illustrates the problem with trying to use average returns, especially ones based on arithmetic returns.

Suppose your portfolio gains 100% in year one and loses 50% in year two. The arithmetic average return is 25%, which sounds like strong performance. But what actually happened to your money? A $100,000 portfolio grew to $200,000 after year one, then dropped back to $100,000 after year two. Your compound annual growth rate is exactly 0%. You ended up with the same money you started with despite a reported average return of 25%.

The compound annual growth rate (CAGR) is a better metric, and for a retirement account balance only. It is not perfect when you are taking income from your portfolio. It shows the single annual rate at which your investment would have grown to reach its actual ending value from its starting value over the full period. CAGR accounts for the compounding effect of volatility in a way that arithmetic averages do not. When evaluating any investment’s historical performance, CAGR is what tells you what actually happened to your money.

This distinction matters enormously for retirement income planning. If your financial projections are built on arithmetic average returns rather than CAGR, your expected portfolio value at retirement, and therefore your projected sustainable withdrawal amount, will be overstated. That gap between projection and reality can mean arriving at retirement with less than you planned for and needing to adjust your lifestyle as a result.

Relying on CAGR gives you a better idea, but taking income from your account when the market is down, and paying fees on top of that, can distort the CAGR some too. Bottom line, any prediction of how much you can spend, for how long, and how much you are likely to pass to your heirs when your income is coming out of that account is likely to differ greatly from any estimate you receive from anyone. Because nobody knows what sequence those returns are going to come in retirement.

And here is another issue to go along with the income issue. We ran the S&P 500 daily closes back to January 1950. The index finished lower than the day before on 46.2% of all trading days, and no decade in that stretch came in under 43% or over 49%.³

We ran the biggest fall inside each year too. Across all 76 years from 1950 through 2025 that averaged 13.7%, and not one of those years went by without a decline somewhere in it. Not one.³

Here is the part that should get your attention. In the 55 years that finished higher, the market still fell 10.4% along the way. In 1987 it fell 33.5% inside the year and still ended higher than it started. In 2020 it fell 33.9% and ended up 15.3%. Last year it fell 18.9% and ended up 16.7%.³

J.P. Morgan Asset Management puts the average drop inside the year, what they call the intra-year decline, at 14.1%⁴, and says in its Guide to the Markets that it is quite common to see a significant decline during the year and still a healthy positive return by the end of it.⁵ Our 13.7% is a little lower than their number because we measured on closing prices, which miss the low the market actually touched during the day. Different data, same answer.

If you are taking income on a monthly basis from your market based account, remember the market does not move in a straight line.

That is not one bad stretch either. It holds in every decade since 1950.

Not one decade in that span drops below 43% or climbs above 49%. A down day is not an event. It is close to a coin flip, every decade, for seventy-six years. If your monthly income is being sold out of that account, roughly half of those sales happen on a day the market just moved against you.

If you are taking withdrawals out during those downturns along the way, all bets are off when it comes to basing your potential retirement success on any kind of average returns.

How Volatility Drag Amplifies the Illusion

The gap between arithmetic average returns and CAGR grows larger as portfolio volatility increases. This phenomenon is called volatility drag, and it is one of the reasons that high-volatility investment strategies often underperform their advertised averages by more than investors expect.

The mathematical relationship is straightforward: the greater the swings in annual returns, the larger the gap between the arithmetic average and the true compound growth rate. A portfolio that swings wildly between large gains and large losses will have a much lower CAGR than its arithmetic average suggests, even if the average looks impressive.

For retirement income planning, this means that volatility is not just a risk tolerance issue. It is a return erosion issue. Two portfolios with the same arithmetic average return but different volatility levels will produce different actual wealth outcomes, with the more volatile portfolio consistently underperforming on a CAGR basis. Reducing unnecessary volatility, particularly in the years approaching and entering retirement, preserves more of what your portfolio’s average return appears to promise.

Here is a crazy question for your consideration. If traditional planning’s compensation model is based on a percentage of the assets they manage, could the plans used in retirement be purposely built to be complex, and to sound so complex, that you feel you need them managing your money?

How Investment Fees and Expense Ratios Compound Against You

Investment fees work the same way as investment returns, only in reverse. Just as compound growth builds wealth exponentially over time, compound fee drag erodes it exponentially. Even fees that appear small in percentage terms can become enormous in dollar terms over a 20-to-30-year retirement horizon.

Here is the dollar impact on a $100,000 portfolio earning a 7% gross return before fees over 30 years:

• With no fees at all: Ending balance approximately $761,226
• At 0.75% annual fee: Ending balance approximately $616,408, which is $144,818 less
• At 1.75% annual fee: Ending balance approximately $464,155, which is $297,071 less

Those gaps are what the fee actually costs you. Not the small percentage on the statement, but $144,818 at three quarters of a percent and $297,071 at one and three quarters percent, money that compounded inside the fee structure rather than inside your retirement account. It is real wealth that existed but was diverted before it could work for you. Most investors never see this number because fees are deducted from returns before they are reported, making the true cost invisible in any given year while remaining enormous over a full retirement horizon.

Many investors also pay multiple layers of fees simultaneously without realizing it. A mutual fund inside a 401(k) may carry its own expense ratio, the 401(k) plan itself may charge administrative fees, and an advisor may charge a separate management fee on top of both. The total cost of ownership across all layers is what determines the true drag on your portfolio, and it is often significantly higher than any single fee figure suggests. Always ask for the total all-in cost before evaluating any investment option.

Understanding Expense Ratios and How to Compare Them

The expense ratio is the annual fee charged by a mutual fund or Exchange Traded Fund (ETF), expressed as a percentage of assets under management. It is deducted from the fund’s assets throughout the year, reducing its net asset value. Lower expense ratios mean more of the fund’s gross return passes through to you as an investor.

The difference between expense ratios across fund categories is significant. Broad market index ETFs from major providers typically carry expense ratios of 0.03% to 0.20% or more. Actively managed mutual funds often carry expense ratios of 0.50% to 1.50% or more. Over 30 years, that difference can compound into the six-figure range even on modest portfolio sizes.

Decades of independent research, including data from Morningstar and Standard and Poor’s SPIVA reports, consistently show that the majority of actively managed funds underperform their benchmark index after fees over long periods.⁶ The funds with the lowest expense ratios do not need to generate those higher returns to justify their cost because their cost is minimal. The funds with higher expense ratios must outperform their benchmark by enough to cover their fee before they deliver any net advantage to investors, and most do not achieve that consistently over time.

How These Forces Connect to Retirement Income Planning

The average return illusion and fee drag are not abstract investment concepts. They directly affect how much income your retirement portfolio can sustainably support.

If your projected retirement portfolio value is based on arithmetic average returns rather than CAGR, you may plan for an income withdrawal rate that the actual portfolio cannot support. If your portfolio has carried 1% to 2% in total annual fees over 20 to 30 years of accumulation, your actual portfolio value may be hundreds of thousands of dollars lower than it would have been at lower costs. Both errors lead to the same outcome: a retirement income plan that does not match the resources actually available to fund it.

This is one of the reasons Lifestyle-First retirement income planning uses guaranteed lifetime income, which we call Protected Lifetime Income, for not only your essential expenses, but also your adventures, your experiences and the memories with those you love, rather than relying entirely on portfolio withdrawal assumptions. Protected Lifetime Income, also known as guaranteed lifetime income, is contractually guaranteed regardless of what markets do, what your portfolio’s actual CAGR turned out to be, or what fee drag has accumulated over decades. When your essentials are covered by guaranteed income, the gap between projected and actual portfolio performance becomes a planning inconvenience rather than a lifestyle threat. See What Is Guaranteed Retirement Income for the full framework.

Myths and Truths About Fees and Average Returns

• Myth: A 1% fee is too small to matter in the context of overall returns.
  Truth: Over 30 years, the difference between a 0.75% fee and a 1.75% fee is $152,253 on a $100,000 portfolio growing at 7% gross. That is why it is worth shopping your fees and finding out what you are actually paying. Fee drag compounds against you at a similar exponential rate that investment returns compound for you.
• Myth: Average returns tell you what your money actually earned.
  Truth: Arithmetic average returns overstate actual performance whenever there is any volatility. CAGR is the only accurate measure of what your money compounded to over a given period.
• Myth: Higher fees mean better management and better returns.
  Truth: Decades of research show that lower-cost funds outperform higher-cost funds on a net-of-fee basis over long periods. Cost is one of the most reliable predictors of future relative performance.
• Myth: I only pay one fee on my investments.
  Truth: Most investors pay multiple simultaneous layers including fund expense ratios, 401(k) plan administrative fees, and advisor management fees. The total all-in cost is what matters, and it is often higher than any single disclosed figure.
• Myth: Strong performance can make up for high fees over time.
  Truth: Very few actively managed funds beat their benchmark index after fees consistently over long periods. The data from Standard and Poor’s SPIVA reports shows this persistently across most fund categories and time horizons.⁶
• Myth: The average return illusion only affects investors who are not paying attention.
  Truth: Arithmetic average returns are mathematically misleading for anyone whose portfolio experiences any volatility, regardless of how carefully they monitor their investments. It is a structural feature of how averages are calculated, not a reflection of investor sophistication.

Pros and Cons of Understanding Fees and Real Returns

Pros of understanding fees and the average return illusion:

• Lets you evaluate investment performance honestly using CAGR rather than misleading arithmetic averages
• Helps you identify and minimize fee drag across all layers of your investment costs
• Leads to more accurate retirement income projections based on what your portfolio will actually support
• Guides you toward lower-cost options that research consistently shows produce better net outcomes
• Strengthens the foundation on which your Lifestyle-First income plan is built

Cons of ignoring fees and relying on advertised average returns:

• Projected portfolio values will be overstated, leading to income plans that cannot be sustained
• Fee drag compounds silently over decades, reducing actual wealth by hundreds of thousands of dollars
• Withdrawal strategies built on arithmetic average return assumptions will be more aggressive than the actual portfolio can support
• The gap between expected and actual portfolio performance is discovered at retirement, when it is hardest to correct

Summary

Investment fees and the average return illusion are two of the hidden forces eroding retirement wealth. Arithmetic average returns consistently overstate what portfolios actually earned because they ignore the compounding effect of volatility. CAGR is the most realistic measure of what your money actually did. Fee drag compounds against you at a similar exponential rate that returns compound for you, turning what appears to be a small annual cost into a six-figure lifetime loss. Understanding both forces leads to more accurate retirement income planning, lower costs, and a retirement income structure built on what your portfolio can actually support rather than what advertised numbers suggest it might.

Frequently Asked Questions

How do fees and the average return illusion affect how much income $500,000 can generate?

If your $500,000 portfolio was built using arithmetic average return projections and carried high fees over the accumulation period, its actual value may be significantly lower than expected. A portfolio that appeared to average 8% but had a CAGR of 6% due to volatility drag, combined with 1.5% in annual fees, could be hundreds of thousands of dollars smaller than projected. That directly reduces how much guaranteed income it can support in retirement.

How do fees and real returns affect how much I actually need to retire?

If your retirement target is based on arithmetic average return projections, you may be underestimating how much you actually need. A portfolio built on CAGR-based projections that also accounts for realistic fee drag will give you a more accurate picture of what you need to accumulate and what income it can sustain. Accurate inputs produce accurate plans. Optimistic inputs produce plans that fail when reality arrives.

How does Lifestyle-First planning protect against the average return illusion and fee drag?

Lifestyle-First planning uses Protected Lifetime Income for essential expenses rather than depending entirely on portfolio withdrawal assumptions. That means the gap between projected and actual portfolio performance, caused by arithmetic average return illusions and fee drag, affects your discretionary spending layer but cannot threaten your essential income floor. Your must-have spending is guaranteed contractually, not dependent on what your portfolio’s CAGR actually turned out to be.

What is Protected Lifetime Income and how does it relate to fee drag?

Protected Lifetime Income is a contractually guaranteed income stream that pays you for life regardless of market performance or portfolio value. Because it is guaranteed by the issuing insurance company rather than dependent on portfolio withdrawals, it is immune to both the average return illusion and fee drag on the growth portfolio. Decades of fee drag that reduced your portfolio by $200,000 do not reduce your PLI income by a single dollar.

What is a Guaranteed Lifetime Withdrawal Benefit and how does it relate to investment fees?

A GLWB is a rider on a fixed indexed annuity that guarantees you can withdraw a set percentage of a protected income base for life, even if your account value drops to zero. Unlike a portfolio withdrawal strategy that is directly harmed by fee drag and return distortion, the GLWB income guarantee is contractual. Your guaranteed withdrawal amount is based on your income base and payout factor, not on what the underlying account earned after fees.

How do fees and the average return illusion make the 4% rule even less reliable?

The 4% rule was derived from historical return data that predates today’s fee environment and does not account for the gap between arithmetic average returns and CAGR. A portfolio carrying 1% to 2% in total annual fees is effectively operating on a 5% to 6% net return in a 7% gross return environment, which means the 4% withdrawal rate consumes a much higher percentage of actual net growth than the rule assumes. Fee drag and return distortion together make the already-questionable 4% rule even less reliable as a planning assumption.

How do fees and the average return illusion connect to the broader tax drag problem?

Fee drag and tax drag operate through the same mechanism: both reduce the net return your portfolio actually delivers to you. A portfolio carrying high fees and generating significant taxable events from active management may be delivering a net-of-fee, net-of-tax return that is dramatically lower than its gross return or advertised average suggests. Understanding both the fee layer and the tax layer of your total investment cost is essential for building an accurate retirement income plan.

Is the 4% rule still safe given fee drag and return distortion?

Morningstar’s 2025 research recommends starting at no more than 3.9% for 90% confidence over 30 years, and that figure does not fully account for the compounding effect of fee drag or the gap between arithmetic averages and CAGR on individual portfolios.⁷² For most retirees whose accumulation period involved meaningful fee drag and whose projections used arithmetic average returns, the realistic sustainable withdrawal rate may be lower than even the revised 3.9% figure suggests.

Can bucket or guardrail strategies overcome the impact of fee drag?

Bucket and guardrail strategies improve on static withdrawal rules but do not address the underlying portfolio value reduction caused by fee drag over the accumulation period. If fee drag has reduced your portfolio by $200,000 over 30 years, guardrails will help you manage withdrawals from a smaller base more efficiently, but they cannot restore the wealth that compounded into fee structures rather than into your account. Starting with a lower-cost portfolio is the only solution to fee drag. Guardrails manage the portfolio you have, not the one you could have had.

Are income protection solutions a fit for retirees concerned about fee drag and return distortion?

For the portion of retirement income covering essential expenses, PLI solutions remove the dependence on portfolio performance entirely. Your guaranteed income does not fluctuate based on what your portfolio’s CAGR turned out to be or what fee drag accumulated over decades. For the growth portfolio covering discretionary spending, choosing low-cost index funds with minimal expense ratios and using CAGR rather than arithmetic averages for projections gives you the most accurate foundation for planning.

How do fees and the average return illusion interact with sequence of returns risk?

Fee drag and return distortion both reduce your portfolio’s actual value relative to projections, which means your portfolio enters retirement smaller than expected. A smaller portfolio is more vulnerable to sequence of returns risk because early withdrawals represent a larger percentage of a reduced base. The combination of fee drag, arithmetic average return illusions, and an adverse return sequence in early retirement can compound into a portfolio depletion scenario much faster than any single factor alone would suggest.

How often is the stock market actually down?

Close to half the time, day to day. We ran the S&P 500 daily closing prices from January 3, 1950 through August 28, 2026, which is 19,285 day-over-day changes. The index closed lower than the previous day 8,911 times, or 46.2%. It closed higher 53.1% of the time and finished unchanged 0.7% of the time. Every decade in that span lands between 43.1% and 48.7% down days, so this is not one bad era pulling the number. It matters in retirement because if you are drawing monthly income out of a market based account, close to half of those withdrawals come on the heels of a down day.

About Kurt H. Jackson

Experience: Kurt H. Jackson has spent more than 16 years working with retirees and pre-retirees who arrived at retirement with portfolios significantly smaller than their projections suggested, only to discover that fee drag and arithmetic average return assumptions had been quietly overstating their expected wealth for decades. He has sat with clients who were told they had averaged 8% returns over 20 years but whose actual CAGR, when calculated honestly, was closer to 5% or 6% after volatility drag and fees. Those conversations are what shaped his conviction that honest return measurement and fee awareness are foundational to any retirement income plan that will actually work. Before founding KJ Financial, he spent 20 years as a Certified Mortgage Planner working with more than 1,000 clients on major long-term financial decisions.

Expertise: Kurt is a Retirement Lifestyle Architect and the creator of the Lifestyle-First Retirement Income Planning framework. He specializes in building retirement income plans that account for the real-world impact of fee drag and return distortion on portfolio values, and in designing Protected Lifetime Income strategies that remove essential spending from dependence on portfolio performance assumptions entirely. He is Life and Health Insurance Licensed in MO, NE, KS, IA, and FL. His practice focuses exclusively on insurance-based, tax-optimized retirement income strategies. He does not manage investments or sell securities.

Authoritativeness: Kurt founded KJ Financial and operates MaxMyRetirementIncome.com as a dedicated educational resource for retirees. His analysis of fee drag and the average return illusion is grounded in independently published research and data from Morningstar, Standard and Poor’s SPIVA reports, and the SEC, applied to the practical retirement income planning decisions his clients face every day. The mathematical relationship between arithmetic averages, CAGR, volatility drag, and fee compounding presented on this page reflects established financial mathematics, not proprietary claims.

Trustworthiness: KJ Financial is a compliance-first firm. All fee drag calculations on this page use illustrative assumptions and are for educational purposes only. Actual results depend on specific portfolio composition, fee structure, time horizon, and market conditions. Kurt H. Jackson is not a securities broker, registered investment advisor, or CPA. He does not manage investment portfolios or provide investment advice. His guidance on fees and return measurement is educational and income-planning focused. Guarantees rely on the claims-paying ability of the issuing insurance company.

Contact KJ Financial:
1014 E. 5th St., Maryville, MO 64468
Direct: 816.582.5532
Email: kurt@kjfinancialonline.com
Website: www.MaxMyRetirementIncome.com

Educational only. Not tax, legal, or individualized investment advice. All fee drag calculations are illustrative and assume a $100,000 starting balance at 7% gross annual return over 30 years. Actual results will vary based on portfolio composition, fee structure, time horizon, return sequence, and market conditions. All figures are for educational purposes only and are not a prediction or guarantee of any specific outcome.

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See exactly what a 1% fee costs you in actual retirement income with the Fee Impact Calculator.

Fees aren’t the only silent drain, the tax structure of a 401(k) can cost just as much. Read I Drank the 401(k) Kool-Aid. Here’s What the Math Actually Says.

Sources

1. Michael Kitces, “The Impact of Fees And Investment Costs on Safe Withdrawal Rates,” Kitces.com. The Kitces Report research finding that a 1% increase in investment expenses reduces the safe withdrawal rate by approximately 0.4%, about 40% of the gross fee.
2. J.P. Morgan Asset Management, Guide to Retirement, slide 4, Life expectancy probabilities. J.P. Morgan’s longevity chart for a non-smoker in excellent health who is age 65 today, giving a woman a 73% chance of reaching 85, 54% of 90, 30% of 95 and 11% of 100, and at least one member of a couple 90%, 74%, 44% and 16%.
3. KJ Financial calculation from S&P 500 daily closing prices, January 3, 1950 through August 28, 2026. Two calculations from the same data. First, across 19,285 day-over-day closing changes the index finished lower than the prior close 8,911 times, which is 46.2%, higher 53.1% of the time and unchanged 0.7%, with every decade between 43.1% and 48.7% down days. Second, taking the largest peak-to-trough fall inside each calendar year and averaging across all 76 complete years from 1950 through 2025 gives 13.7%, with a decline occurring in every one of those years and no exceptions; in the 55 years that finished higher the average largest fall was still 10.4%. Both are measured on closing prices, which understates the true fall because a closing price misses the low the market touched during the day. Yahoo carries actual daily highs and lows only from January 2, 1962; measured that way, 1962 through 2025 averages 15.8%. Each year’s return is measured from its first close to its last close, the same window as the fall.
4. J.P. Morgan Asset Management, What’s driving stock market returns?. J.P. Morgan’s statement that the S&P 500 typically experiences an average intra-year drop of 14.1%.
5. J.P. Morgan Asset Management, Guide to the Markets, Annual returns and intra-year declines. J.P. Morgan’s own description of the chart, which says it is quite common to see a significant intra-year decline and yet a healthy positive return on the year.
6. S&P Dow Jones Indices, SPIVA U.S. Scorecard. SPIVA’s own scorecard, with data as of December 31, 2025, showing that 85.59% of all US large-cap funds underperformed the S&P 500 over 10 years and 89.93% underperformed over 15 years.
7. Morningstar, What’s a Safe Retirement Withdrawal Rate for 2026?. Morningstar’s statement that its 2025 retirement income research puts 3.9% as the highest safe starting withdrawal rate for a retiree seeking consistent inflation-adjusted spending, assuming a 90% probability of having funds remaining at the end of an assumed 30-year retirement.

Every figure on this page was read against the source listed above it on August 30, 2026.