Measuring Investments by the Book

Comparing “book value” to current market value would seem to be the obvious way to measure how your investment is doing, right? Wrong. Here’s the skinny on “book value,” and why it’s not the same thing as the total amount of your investment.

Book value is an important concept, but one that can be confusing to investors when they assess their mutual fund performance. Book value is not, as some might think, the total value of your original investment, as the book value changes each time a transaction takes place and any time a fund pays a distribution that is reinvested. On the surface, a security with a high book value compared to its market value may look like it has lost money. However, book value measures how much tax has been paid along the way. So in fact, that investment may be performing much better than it appears to be.
 
Each time a distribution is paid out and additional units are added to your account, the book value will increase by the distribution amount. This is important in a taxable account because investors are taxed on the distributions earned each year. Over time, if the value of the portfolio increases when you sell fund units, a capital gain is triggered. The capital gain is the market value of the transaction less the book value.
 
If the book value did not increase every year by the amount of the distributions, you would be paying tax twice on the distribution amounts, so it is important that the book value increases with each distribution. But if distributions are not reinvested, the book value will not change.
 
If the book value increases every year, over time it may exceed the market value. This is especially true for income-generating funds. In that case, anyone incorrectly assuming the book value equals the value of the original investment, it would look like you were losing money.
 
The best way to measure performance is to calculate the actual dollar amount you have invested and compare that to the market value of your portfolio, remembering to factor in any withdrawals or deposits of capital. This information is provided on your statements from most fund companies.

Karey Irwin, CFP, is a vice-president and portfolio manager at Leith Wheeler Investment Counsel Ltd. in Vancouver. The article is not intended to provide advice, recommendations or offers to buy or sell any product or service.