An actively managed fund returns 10% per year before taxes but distributes 3% in short-term capital gains annually. An investor in the 32% bracket pays 0.96% per year in tax on those distributions — even if she never sells a share.

Over 30 years, that 0.96% annual drag reduces her $100,000 investment from $1,744,940 (at 10%) to $1,320,590 (at 9.04% after drag).

The silent cost: $424,350. Not from bad stock-picking. Not from high fees.

From a fund that traded too much and passed the tax bill to its shareholders. Tax drag is the compounding cost of paying taxes on investment income year after year instead of deferring that tax. It applies in taxable accounts (not in IRAs or 401(k)s where gains compound tax-deferred).

Three sources create tax drag: 1. Dividend tax — qualified dividends taxed at 15-20%, ordinary dividends at up to 37% 2.