Common Mistake #27: Overpaying for Active Management

Active management often sounds reassuring. A professional is making decisions, monitoring markets, and adjusting positions on your behalf. That oversight feels valuable - especially during volatile periods. According to long-running analyses from sources such as S&P Dow Jones Indices' SPIVA scorecards on active-versus-passive performance, a majority of actively managed funds tend to underperform their relevant benchmarks over long horizons after accounting for fees and costs. SPIVA results consistently show that, across categories and regions, more active funds lag their benchmarks as time horizons lengthen, reinforcing the challenge of generating persistent outperformance after fees.

This article explains why overpaying for active management is a common investor mistake, how fees quietly reshape outcomes over time, and why the cost often matters more than the strategy itself.

Key takeaways

• Fees reduce returns every year, regardless of performance.
• Small fee differences compound into large outcome gaps over time.
• Consistent outperformance is rare and hard to identify in advance.
• The fee hurdle rises as markets become more efficient.
• Paying more doesn't guarantee better results.

Why active management feels worth paying for

Active funds promise discretion. Someone is analyzing data, responding to news, and trying to avoid downturns or capture opportunities. That involvement feels protective.

There's also narrative appeal. Outperformance stories are compelling. Skill feels tangible. Indexing, by contrast, can feel passive - almost negligent.

Up to this point, paying higher fees feels reasonable. You're buying expertise.

That's why this mistake is so persistent.

Here's the math most investors don't focus on

Generally, fees aren't a one-time cost. They are a permanent claim on returns.

An annual fee difference of 0.75% or 1% may sound modest. Over decades, it compounds relentlessly. Every year, fees reduce not only current returns, but also the base on which future returns grow.

So what? Two portfolios earning the same gross returns can end up far apart simply because one paid more along the way.

This is where 'reasonable' fees quietly become decisive.

This is where the performance hurdle becomes unrealistic

To justify higher fees, active managers must consistently outperform - not occasionally, not in short bursts, but over long periods after costs.

That's a high bar.

Market efficiency, competition, and transaction costs make sustained outperformance rare. Even managers who outperform for a time often regress toward the mean. Identifying winners in advance is difficult, and switching managers introduces its own costs.

This is where expectations drift away from probabilities.

Paying for potential is easy. Paying for consistent results is much harder.

Why does overpaying often go unnoticed

Overpaying doesn't feel like losing. Account balances still rise in up markets. Statements don't show 'fees paid' in bold letters. Underperformance reveals itself slowly, often relative to a benchmark.

Behavioral research rooted in prospect theory shows that investors are more sensitive to visible losses than to gradual shortfalls because psychological pain from a loss tends to outweigh the satisfaction from equivalent gains. This cognitive bias leads investors to focus on salient negative outcomes - such as market declines - while often overlooking slow, persistent drags like fee costs, which fall into the latter category. (Based on behavioral finance research on loss aversion and myopic loss aversion.)

The result isn't disappointment. It's quiet underachievement.

Why does this mistake persist across market cycles

Active management tends to shine in stories, not statistics. Short-term success gets attention. Long-term averages don't.

There's also comfort in delegation. Paying someone else feels like risk management - even when the risk is simply transferred into higher costs.

But fees are one of the few variables investors can control with certainty. Markets don't cooperate. Costs do.

This is why fee awareness matters more than market forecasts.

The reframe that changes the decision

Investors who avoid this mistake often adopt a simple reframe:

Fees are a guaranteed expense; outperformance is not.

This reframing shifts focus from hope to arithmetic.

Supporting considerations - such as understanding expense ratios or comparing net-of-fee outcomes - exist to inform decisions, not to rule out all active strategies.

The goal isn't avoiding active management entirely. It's avoiding unjustified cost.

When paying higher fees may still be intentional

Some investors choose active management for specific exposures, strategies, or mandates that differ meaningfully from broad benchmarks. Others value aspects beyond returns alone.

As with other mistakes in this series, the distinction is awareness.

Overpaying becomes a mistake when fees are accepted by default, not when they're understood and chosen deliberately.

Cost doesn't need to be zero. It needs to be earned.