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Terms and conditions for Canada

When looking at an investment statement or account balance, book value is often displayed. But what does it mean and why is it reported? To answer these questions we take a closer look at book value and what it means for investors.

Book value, also known as adjusted cost base (ACB), is calculated by adding the total amount of contributions made by an investor into a mutual fund, plus reinvested fund distributions, minus any withdrawals. Book value is used from a tax perspective to determine if an investor is in a capital gain or loss position on a particular holding. In a formula, book value looks like this:

Book value

Initial investment

Subsequent contributions

Reinvested distributions

Withdrawals

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1. Receive distributions in cash which is paid into their account
2. Have any distributions automatically invested back into the fund

Mutual funds earn dividends and interest from their underlying investments, and may also realize capital gains or losses when securities are sold. Every year, the fund will pay out these earnings or capital gains to its unitholders which are referred to as distributions. Depending on the fund, distributions are paid on a monthly, quarterly or annual basis.

In between distribution dates the value of each unit of the fund, known as the net asset value per unit (NAV), will typically swell as income is earned by the underlying investments. When the distribution is paid, the NAV of the fund will decline by an amount equivalent to the size of the distribution. For investors who have chosen to have distributions automatically reinvested, the amount of the distribution is used to buy additional units in the fund at the lower unit price. As a result, investors who reinvest distributions will see an increase in the overall number of units, but a lower per-unit price. The key point is that the market value of their investment remains unchanged following the distribution. Book value is not impacted if a client chooses to receive distributions in cash. However, clients who reinvest distributions back into the fund will see their book value rise by the amount of the distribution.

There are two reasons for this:

  • First, whether an investor takes the distribution in cash or reinvests it, they will pay tax on the distribution in the year it is paid (other than nontaxable accounts such as RRSPs). The rise in book value accounts for the fact that the investor is paying tax in the current year on a portion of their total gains.
  • A second way to think about it is that when an investor reinvests distributions they are essentially making an additional contribution to their investment.

If you require more information on how this impacts your investments or circumstances, we recommend that you speak to your financial advisor or a tax specialist.

Consider Anne, who makes an initial investment of $1,000 in a mutual fund. She subsequently invests an additional $100 and has set up her account to have any distributions reinvested.

At a later date, the fund pays a $50 distribution which is reinvested in Anne’s account by purchasing additional units.

Along the way, the book value of Anne’s investment changed when she made an additional contribution ($100) and again when she reinvested the distribution ($50).

As noted previously, book value is not impacted by changes in the NAV as the markets move up and down. Since Anne has made no withdrawals, her total book value is now $1,150 ($1,000 + $100 + $50) as seen below.

Initial
investment
$1,000

Additional contribution
$100

Reinvested distribution
$50

Book value
$1,150

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When it comes to evaluating performance, book value is not a useful measure. In some cases the book value of an investment can be greater than market value even though an investor has profited from their investment and could give the false impression that a fund has experienced a loss, even though the value of the total contributions has grown.

Using Anne again as an example, if the market value of her mutual fund has grown to $1,125, she has experienced growth of $25 in the value of her contributions ($1,125 market value minus $1,100 in total contributions). However, if she were to compare the book value of her investment to the market value, then Anne might misinterpret the performance of her investment, as she would see a book value of $1,150 ($1,100 total contributions + $50 reinvested distribution) which is larger than the current market value of $1,125. At a quick glance, what looks like a $25 decline on her investment is in fact a $25 increase. This difference between book value and total contributions can be especially pronounced in funds which produce greater amounts of income, such as bond funds.

Market value
$1,125

Book value
$1,150

Perceived loss
on investment
- $25

Market value
$1,125

Total contributions
$1,100

Actual gain on investment
$25

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To recap, book value is an important number for tax purposes as it determines if an investor is in a gain or loss position on their holding. However, when it comes to assessing performance, book value is a less useful measure and doesn’t provide an accurate representation of an investor’s total return.

Disclosure

This article is not intended to provide individual legal, accounting, tax, investment, financial or other advice and is for informational purposes only. Specific investment strategies should be considered relative to each investor’s objectives and risk tolerance. The information contained herein is provided by RBC Global Asset Management Inc. (RBC GAM) and believed to be up-to-date, accurate and reliable. Information obtained from third parties is believed to be reliable but RBC GAM and its affiliates assume no responsibility for any errors or omissions or for any loss or damage suffered. Publication Date: November 2017.