What Exactly Are Foregone Earnings?
Foregone profits are the gap between actual earnings and those possible without fees, costs, or wasted time. Thus, investment fees, which generally account for a significant fraction of investment returns, account for a large portion of missed earnings.
Lower fees should have yielded a higher return on the investment. Foregone earnings are commonly used to refer to sales charges, management fees, or overall fund expenditures.
Understanding Foregone Earnings
The impact of foregone earnings on investment performance might hinder long-term asset growth. Investors typically pay fees for accessing mutual funds, ETFs, and other pooled investment vehicles. A portfolio manager purchases and sells securities that are actively managed mutual funds. Passively managed ETFs track an index like the S&P 500 and offer lower costs than mutual funds.
Compound returns may transform a seemingly small expense, like a front-end load or 1% management charge, into thousands over time. To avoid lost revenues, investors must investigate investment expenses.
Forgone earnings refer to the cost of losing out on a superior alternative or opportunity, resulting in lost revenue.
Mutual funds Foregone earnings
Sales costs can be costly for investors. FINRA presents a schedule of probable front-end load sales costs for mutual fund investments. See the table below for possible breakpoints where mutual fund sales costs might decrease depending on investment quantity.
Possible breakpoint discounts Investment Amount: Selling Fee
Less than $25,000 – 5.00%
Under $50,000 but at least $25,000: 4.25%
At least $50,000, less than $100,000: or 3.75%
Over $100,000 but under $250,000: 3.25%
Over $250,000 but under $500,000: 2.75%
More than $500,000 but under $1,000,000: 2.00%
$1 million+: zero sales tax
Sales charges might arise throughout the investing process. Distributors pay brokers sales commissions.
Here are three types of sales charges and their timing:
- The front-end sales costs are a proportion of the initial investment at the time of purchase. Class A shares usually incur front-end sales fees.
- Back-end sales costs are the percentage of the investment’s nominal amount at the time of sale. B-shares of a fund usually incur back-end sales costs.
- Over time, the fund steadily lowers deferred sales costs while holding the investment. We can finally eliminate charges. The fund postpones expenses for contingent deferred sales costs based on how long the asset is in it.
Discount brokers charge less for individual investors, and many platforms don’t impose sales fees. Direct-fund firm investments generally avoid sales costs.
Mutual fund intermediary sales fees. A few mutual funds display returns with and without sales charges. The ClearBridge Aggressive Growth Fund records returns with and without sales charges. This fund’s average one-year return minus sales charges was -25.33% as of August 31, 2022. Sales charges dropped the return to -29.62%, costing 4.29%.2
The example shows how foregone earnings impact investment returns. Breakpoint discounts significantly reduce sales costs, enabling reinvestment or compounding of investment earnings for higher long-term returns. Investors can check mutual fund breakpoint discounts to determine if they qualify and what they require.
Pay Operating Costs
Mutual fund operation expenses also reduce investor earnings. Typical mutual fund operating expenses include management, distribution, transaction, and administrative charges. Mutual funds may provide gross and net expense ratios, which include these fees. The fund has waivers and reimbursements if a net expense ratio is given. After discounts expire, the fund’s expense ratio rises to its gross expense ratio.
Management fees and gross versus net expense ratios might help investors compare funds’ foregone profits. Passively managed funds have fewer expenses than actively managed ones. Active funds have higher management and transaction fees.
Suppose you have $10,000 to invest; one fund costs 0.5% and the other 2%. Both funds cover a comparable market niche. The 2% fund would reduce your yearly return by $200. Investing in the 0.5% fund costs $50. If you invested in the 2% fund, fund costs offset $150 in profits.
Fees for redemption
Mutual funds may levy redemption fees to keep investors from short-term trading. The fund company sets these costs. The issuer can choose payment dates from 30 to more than a year following the purchase. The fund receives redemption fees for trading and operations. Eliminating redemption costs might also decrease lost revenue.
- Foregone earnings are the difference between an investment’s actual profits and the potential earnings without expenses.
- Investment fees cost the investor funds, which are foregone earnings.
- Foregone profits presume lower-fee investors receive higher market returns.
- Mutual fund investors lose earnings due to sales and operation expenses.