What is Foregone Earnings?
390 reads · Last updated: December 5, 2024
Foregone earnings represent the difference between earnings actually achieved and the earnings that could have been achieved with the absence of fees, expenses, or lost time. As such, a large portion of foregone is represented by the amount that the investor spent on investment fees, which often make up a sizable percentage of investment earnings.The assumption is that if the investor had been exposed to lower fees, they would have automatically earned a better return. The concept of foregone earnings is typically used when referring to sales charges, management fees, or total expenses paid to funds.
Definition
Lost earnings represent the difference between the actual realized returns and the potential returns that could have been achieved without fees, expenses, or time delays. It is often used to describe the amount investors spend on investment fees, which can significantly impact investment returns.
Origin
The concept of lost earnings originated from studies on the impact of investment fees, particularly in the late 20th century, as the diversification of investment products and services led investors to focus on the effect of fees on net returns.
Categories and Features
Lost earnings are mainly divided into two categories: direct fees and indirect fees. Direct fees include management and sales fees, which are usually explicitly listed. Indirect fees may include opportunity costs, such as potential returns missed due to choosing high-fee funds. The characteristics of lost earnings include their implicit and cumulative nature, which can significantly affect investment returns over the long term.
Case Studies
Case Study 1: Suppose an investor chooses a fund with a 2% management fee, while another similar fund has a 0.5% fee. Under the same market conditions, the low-fee fund may yield higher net returns over the long term. Case Study 2: An investor pays high advisory fees when selecting an investment advisor, which further reduces net returns when the portfolio underperforms.
Common Issues
Investors often underestimate the impact of fees on long-term returns, mistakenly believing that high fees necessarily lead to high returns. In reality, lower fees can often enhance net returns. Additionally, investors should regularly review investment fees to ensure the cost-effectiveness of their portfolios.
