Cost Basis Is Different From Return

Investor brokerage statements sometimes show a “cost” for an investment in addition to its value. For example, a year-end Vanguard account statement for an investment in the Wellesley Income mutual fund shows the following:

Symbol	Fund Name	Average Price Per Share	Total Cost	Value on 12/31/16
VWINX	Wellesley Income Fund Inv.	$25.56	$28,638.94	$28,534.98

At first glance, the total cost of $28,638.94 exceeds the value of $28,534.98 on 12/31/2016, so you might think you “lost” money. But what does “cost” mean in this case? The cost shown on the account statement is the “tax cost” of the fund (also known as cost basis). It is used for calculating capital gains for tax purposes when you eventually sell the fund. The cost basis includes your purchases (what you put into the fund), as well as all the dividend and capital gain distributions that you reinvested into the fund. You pay income tax on these each year, and since the distributions were used to buy more shares of the same investment, they add to the cost basis for the fund. If you took the distributions in cash, you would still pay tax on them, but they would not add to cost basis for the fund.

The table below shows the initial purchase and all the various distributions through the end of 2016.

Date	Transaction Description	Share Price	Shares	Total Amount
5/12/2014	Initial Purchase	25.61	979.312	$25,080.17
6/20/2014	Dividend Received	25.91	6.841	$177.26
9/19/2014	Dividend Received	25.83	7.025	$181.45
12/17/2014	Dividend Received	25.34	8.623	$218.50
12/17/2014	Long-term Capital Gain	25.34	16.814	$426.07
12/17/2014	Short-term Capital Gain	25.34	0.901	$22.84
3/26/2015	Dividend Received	25.58	6.895	$176.38
6/19/2015	Dividend Received	25.43	7.265	$184.75
9/18/2015	Dividend Received	24.71	7.864	$194.33
12/16/2015	Dividend Received	24.59	9.403	$231.22
12/16/2015	Long-term Capital Gain	24.59	25.159	$618.67
12/16/2015	Short-term Capital Gain	24.59	0.635	$15.62
3/16/2016	Dividend Received	24.96	6.988	$174.43
6/16/2016	Dividend Received	25.7	7.886	$202.66
9/16/2016	Dividend Received	25.9	7.376	$191.03
12/23/2016	Dividend Received	25.46	9.755	$248.37
12/23/2016	Long-term Capital Gain	25.46	11.189	$284.86
12/23/2016	Short-term Capital Gain	25.46	0.406	$10.33
			Total:	$28,638.94

The Total in this table is the same as the Total Cost shown in the summary statement excerpt above. It is what you would report to the IRS as the cost basis of the fund if you decided to sell it.

But what did you actually earn on the investment? The only money you contributed is the initial purchase of $25,080.17 on May 12, 2014. All reinvested dividend and capital gain distributions afterward were part of the investment earnings. As shown in the chart below (from the Vanguard website for the account), the total investment returns through December 31, 2016 were $3,454.81. Adding these two together gives December 31, 2016 account value of $28,534.98 from the first table.

So, the total return from May 12, 2014 through December 31, 2016 was $3,454.81. This is 13.78 percent over a little more than 2 ½ years ($28,534.98/$25,080.17 -1)x100. This corresponds to an average annual rate of return of about 5 percent during the period from May 2014 through December 2016.