Cost basis is a part of your portfolio.
How to make the most of it.
I wanted to shed some light on a topic that is likely much more relevant to investors who are DIYers. As a professional, this is something that I always take into account as I believe it is a core component of portfolio management when it comes to taxable brokerage accounts.
Today’s topic: cost basis.
Our cost basis is the price we paid for an asset. If I buy $100 worth of a stock, that value is important and it will dictate tax implications upon selling. Sell above $100 and I have a gain, below $100 and I have a loss.
However, things can get a little more complex as we dollar-cost average. If someone were investing monthly for 5 years, they’d have 60 different tax lots. If they reinvested their dividends, they’d have even more lots.
When it comes time to sell, the lots will dictate the gain or loss realized, which impacts us on a net basis as this will lead to a taxable event.
Generally speaking, there are 3 main ways in which custodians will log a sale. FIFO, first-in first-out. LIFO, last-in first-out. And my personal favorite, individual/specific lot identification.
FIFO will have the first shares ever purchased sold first. Over long time periods, we could assume that the earliest positions likely have some of the largest embedded gains.
LIFO will have the most recent shares ever purchased sold first. Because the last shares are going to be sold, an investor may find themselves realizing short-term gains with no intention of doing so.
Finally, specific lot identification can allow us to choose exactly which shares we want to sell.
Side note: Unless otherwise indicated, a custodian may have a default setting. This is where some individual investors go wrong. I’d much prefer the flexibility of choosing exactly which shares I am going to sell.
There are many advantages to the specific lot ID method and they pretty much all revolve around tax.
In high income years, it may make sense to liquidate shares that will have the smallest gains, leading to as little tax drag as possible.
For some that are taking extended periods away from work, they may look to gain harvesting. In which shares with the largest gains are sold in hopes of achieving the 0% LTCG tax bracket, effectively harvesting the gain with little to no tax implications at all.
At the end of the day, any chance we get to put more personalization in our hands, I’m looking to do so. But this one instance is something that can fly under the radar for DIY investors.
Stacking the odds in our favor is one of the best ways to get ahead in personal finance.
This is for informational purposes only and is not intended as legal, tax, or investment advice or a recommendation of any particular security or strategy. The investment strategy and themes discussed herein may be unsuitable for investors depending on their specific investment objectives and financial situation. Opinions expressed in this commentary reflect subjective judgments of the author based on conditions at the time of publication and are subject to change without notice. Past performance is not indicative of future results.