Which Cost Basis Method Should I Choose?

[nico08]

I received the following message from Vanguard, and I am wondering which method I should choose. Any advice? Thanks.


Want to know how you can save time when selling your Vanguard mutual funds by phone or online? The answer's simple: Choose a preferred cost basis method today.

Because of important regulatory changes now in effect for mutual fund investors, Vanguard—along with other investment firms—must report cost basis details to the IRS for all mutual funds (excluding money market funds) you acquire on or after January 1, 2012, and later sell in taxable (nonretirement) accounts. We'll begin reporting this information to the IRS in 2013 (for the 2012 tax year) and will also continue reporting it to you. (If you've already set your cost basis method, please disregard this e-mail.)

What is cost basis?
Cost basis is generally the price you pay for your shares. The price includes reinvested dividends and capital gains, as well as any transaction fees. Cost basis is used to determine gains and losses on any shares that you sell in taxable mutual fund accounts.

In the past, Vanguard has used one method as its default to calculate cost basis for mutual funds—average cost. Our enhanced cost basis service now offers more accounting methods. So it's important for you to give consideration to which method is the most appropriate for your tax situation before you sell shares. The available methods are:


Average cost. Calculates the average cost per share for each share you own. This remains the Vanguard default for mutual funds.


First in, first out (FIFO). Shares with the oldest acquisition date are sold first.


Specific identification (SpecID). When you sell shares (or lots), you tell us which ones to sell, determining your capital gain or loss.

 

[GrayHare]

I typically use average since it's the default and in most cases the tax varies little from the other options. You might use FIFO if you want to tax loss harvest an investment in which you had initially purchased shares at a very high price, then later more shares at a much lower price.

 

[Animorph]

You should use Specific Identification so that you have total control over your gains. However that is also more complex since you have to make a decision about which shares to sell each time you sell.

If you don't want to do that, then I would pick the method that matches what you were doing in the past. That way it will automatically do what you are used to and expecting.

 

[easysurfer]

IMO, I'd choose average and be done with it, keep it the easiest.

Here's a previous discussion on this very topic:

http://www.early-retirement.org/forums/f28/vg-requesting-to-set-cost-basis-method-58578.html