Foregone earnings represent the difference between the earnings actually achieved and the higher potential earnings that were missed due to fees, expenses, or lost time. A significant contributor to foregone earnings is the amount spent on investment fees, which can constitute a large portion of investment earnings.
The assumption is that exposure to lower fees would result in better returns. Foregone earnings usually refer to sales charges, management fees, or total expenses paid to funds.
Key Takeaways
- Foregone earnings are the difference between an investment’s actual returns and what could have been earned without fees.
- These earnings represent the investment capital spent on fees.
- Foregone earnings suggest that lowering fees can lead to better market returns.
- Investment fees causing foregone earnings include sales charges, operating fees, and more.
Building Wealth: Understanding Foregone Earnings
In terms of investment performance, foregone earnings can significantly drag on the long-term growth of assets and investments. Fees are often charged for access to investment opportunities like mutual funds, exchange-traded funds (ETFs), and other pooled investment vehicles. Mutual funds are collections of securities managed actively, whereas ETFs typically track indices, resulting in lower fees.
Even seemingly small fees, such as a 1% management fee, can erode thousands of dollars over time due to compound returns. Investors must thoroughly research and consider the costs of each investment to minimize foregone earnings. Remember, foregone earnings are a kind of opportunity cost—losing out on potentially better financial opportunities elsewhere.
Exceed Expectations: Examples of Foregone Earnings
Sales Charges
Sales charges can significantly impact investors. Here’s a sample schedule of potential front-end load sales charges for mutual funds:
| Investment Amount | Sales Charge |
|---|---|
| Less than $25,000 | 5.00% |
| $25,000 - $49,999 | 4.25% |
| $50,000 - $99,999 | 3.75% |
| $100,000 - $249,999 | 3.25% |
| $250,000 - $499,999 | 2.75% |
| $500,000 - $999,999 | 2.00% |
| $1 million or more | No sales charge |
Sales charges, calculated as a percentage of the initial investment, can occur at various points. There are three main types:
- Front-end sales charges: Applied when the investment is initially purchased, usually linked to Class A shares.
- Back-end sales charges: Applied when the investment is sold, generally associated with Class B shares.
- Deferred sales charges: These reduce over time as the investment remains in the fund, contingent on the holding period.
Investors often pay lower fees with discount brokers and may bypass sales charges by investing directly. Here’s an example emphasizing the importance of understanding sales charges: Suppose the average return without sales charges is -25.33%, but with sales charges, it drops to -29.62%, resulting in significant foregone earnings.
Embracing Savings: Fund Operating Fees
Investors also face foregone earnings from mutual fund operating fees, which often include management fees, distribution fees, transactions fees, and administrative costs. These fees contribute to the fund’s expense ratios; a net expense ratio shows the cost after applying any waivers or reimbursements.
Consider this example: With $10,000 to invest, one fund charges 0.5%, and another charges 2%. Assuming similar market exposure, the 2% fund would reduce your returns by $200 annually, compared to the $50 in the 0.5% fund, resulting in $150 foregone earnings due to higher fees.
Redemption Fees
To curb short-term trading, mutual funds may impose redemption fees. These fees vary by the fund company and can apply from 30 days up to over a year after the purchase. The collected fees are used for trading and operational cost recovery.
Avoiding redemption fees can also help reduce potential foregone earnings. Doing so ensures a larger portion of your investment earns compound returns, maximizing long-term growth.
Related Terms: opportunity cost, management fees, mutual funds, exchange-traded funds (ETFs), compound returns.
References
- Financial Industry Regulatory Authority (FINRA). “Mutual Funds: Fees & Expenses”.
- Franklin Templeton. “ClearBridge Aggressive Growth Fund”.
