Now that tax season is upon us, we thought we should reflect on some of the more common discussions we have had with clients throughout the year about taxes and how they relate to investments. Generally, a capital gain is the increase in value of an asset during the time you own it. In this Portfolio Minute, we will look at the differences between market value, book value, and net invested value.
Book Value vs Market Value
The market value of a mutual fund is the value of the fund at a specified point in time. This is calculated by the NAV (net asset value) or price of the mutual fund multiplied by the number of units an investor holds. Book value (or the adjusted cost base) on the other hand, is all contributions into a mutual fund plus all reinvested dividends minus all withdrawals. Funds are valued at the end of each business day.
While book value versus market value is valuable for tax purposes, a common mistake investors tend to make is comparing the book value against the market value to determine a fund’s performance. This can be misleading as it is not always an accurate reflection of the investor’s total return. For example, if an investor had a mutual fund with a market value of $1,000 and the book value was $1,050, the investor perceives that there is a loss of $50.
Book value helps an investor or your advisor determine if the investment you hold is in a capital gain or capital loss position. A capital gain or a loss is only realized when a redemption from the mutual fund is made. If there is a gain at the time that the redemption is made, 50% of the capital gain is taxed at the marginal tax rate of the investor. If there is a loss at the time of the redemption, 50% of the capital loss can be applied back up to three years or carried forward indefinitely to offset any future capital gains.
Net Invested vs Market Value
Now that we have taxes sorted out, let’s move on to the age-old question: How have my investments done? A better way to assess the performance of the mutual fund is to subtract the initial amount invested (also known as net invested) from the market value. Using the example from above, if the investor made an initial purchase of $900 and made no contributions then there is an increase of $100 ($1,000 – $900) in the mutual fund. At the same time, the book value of $150 came from reinvested dividends thereby giving us a higher book value. Finding net invested on your statements isn’t always easy to find but if this is something clients are interested in we can easily provide it.
When assessing the performance of a fund, the net investment is subtracted from the market value. This tells us if there is an increase or decrease in the total return of the investment. Some, but not necessarily all, of this gain will be found on a T3 or T5 slip indicating the total income earned and reinvested in the fund.
By contrast, when assessing the tax implications of a redemption we need to subtract the book value from the market value, producing a capital gain or loss. This gain or loss will be reported on a T5008 generated by the fund company telling us if there was a capital gain or loss to be reported.
One of the many benefits of working with CH Financial is having one firm handling both investments and taxes. We take responsibility for both, thus making your life easier!
In our next Portfolio Minute, we look at the question, “My investment is down, so why do I still owe taxes?”
Devin Gorgchuck, Wealth Advisor
& Your CH Financial Team