If you have a “regular” taxable investment account (anything other than your tax advantaged accounts such as your 401k, 403b, IRA, Roth etc.), you should understand the different cost basis tracking methods and how they affect your taxes when you sell. Fidelity has a good article describing the background.
If you only have tax advantaged accounts at this time, this doesn’t apply to you yet. It’s still good to know for the future.
When I looked at my taxable account at Fidelity to see whether any shares I bought this year can be sold for a tax loss, I noticed that my shares in a mutual fund I purchased at different times this year all had the same cost basis per share. Fidelity apparently was displaying the average cost.
If you want to minimize taxes when you sell an investment, or if you want to do tax loss harvesting, the best method to track your cost basis is specific identification. You pick the lot that’s most advantageous to you when you sell. Unfortunately at many places including Fidelity, Vanguard, and Schwab, the default tracking method for mutual funds is average cost, which isn’t the best.
You can change it from average cost to specific identification. It’s best to do it now before you have any sales that complicate things. Here’s how to do it at Fidelity and Vanguard.
1. Under Accounts & Trade, click on Update Accounts / Features.
2. Then find and click on Cost Basis Information Tracking in the navigation pane on the left hand side.
3. Click on Convert under Mutual Funds.
4. Read the information on the next page. Follow the prompts.
Switching from Average Cost to Actual Cost means you can pick which lot(s) the shares will come from when you sell. If you don’t pick or if you forget to pick, the default disposal method kicks in. I suggest also changing it from the default First In, First Out (FIFO) to something else.
Fidelity offers many choices. Be sure to read and understand what each method means. I chose Tax Sensitive.
1. On the Balances and holdings page, click on Cost basis.
2. Click on View/Change cost basis method on the right hand side.
You don’t have as many choices as in Fidelity, just Average Cost, First In First Out, and Specific Identification.
I don’t have an account there. According to a FAQ on Schwab’s website:
The default for mutual funds is the average cost method. You can check or change the default cost basis method on file for your accounts in Account Settings.
If it’s not obvious how to see or change your cost basis tracking method, contact customer service.
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