What Is an Average Cost Basis Method?

What Is an Average Cost Basis Method?

By Charles Joseph | Editor, Financial Affairs
Reviewed by Corey Michael | Senior Financial Analyst

The average cost basis method is a way of calculating the value of an investment. It involves totaling the amount you’ve spent to acquire all shares of a particular investment and then dividing that amount by the total number of shares you own. This approach provides you with an average cost per share. It is commonly used for mutual funds, as it simplifies the process of tracking each individual purchase.

Related Questions

1. What are the other methods of calculating cost basis?

Aside from the average cost basis method, there are two other conventional methods: the first-in-first-out (FIFO) and the specific identification method. FIFO assumes that the first shares bought are also the first ones sold. Specific identification, on the other hand, leaves it up to the investor to identify which specific shares are sold.

2. Why is cost basis important for investors?

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Knowing your cost basis is key to accurately calculate the capital gains or losses when you sell the investment. It helps determine the taxable income you’ll report on your tax return. A lower cost basis means more capital gain, while a higher cost basis results in less gain or more loss.

3. How does the average cost basis method affect mutual fund taxes?

This method can simplify tax calculations for mutual fund investors. Since it averages the costs, it may lead to lower taxable gains when some shares are sold, compared to methods like FIFO which might sell off lower-cost shares first.

4. Can I switch my cost basis method after the purchase?

Yes, you can change your cost basis method, but the change will only affect future purchases. Any past transactions will retain the method used at their time of purchase. It’s advised to consult with a tax professional before changing your method.

5. Do all brokerages offer all cost basis methods?

No, not all brokerages offer all the methods. Some may only offer average cost or FIFO. Therefore, it may be a factor to consider when choosing a brokerage if you have a preference in the cost basis methods.