Book Value

The Financialist • Issue 105 • April 2010 

BY BRYSON MILLEY BA CFP
 
It is commonly assumed that the book value on an investment statement is the amount of money that one has deposited into their account or investment, but this is only partially true. Book value is actually a combination of the money deposited, money transferred-in, reinvested distributions or dividends, and rebalanced holdings, less withdrawals at their input cost.

The easiest of these to follow is new money that is deposited and/or assets that are transferred in; this is the base of the book value. If this money were never invested, the book value would never change... nor would the market value. But, as soon as this money is invested in a portfolio of holdings, the book value typically grows.

For instance, mutual funds are usually a basket of stocks and/or bonds. Stocks and bonds often have income paid to the owner by way of dividends and coupon payments. As well, a mutual fund will often sell assets at a profit throughout a year. In all cases, these dividends/ coupons/profits are to be distributed to the unit-holders of the mutual fund by way of a distribution. Most often these distributions are reinvested by buying more units of the fund. Each time this happens, the book value increases. The investor did not add new money to the portfolio, but the reinvested distribution (which is profit) increased the book value.

As another example, over time, a portfolio of holdings can drift from its targeted allocation due to the ebb and flow of investments. If a particular asset is intended to be worth 50% of the portfolio, and over time it creeps up to be worth 55%, often the portfolio is rebalanced. This means selling some of the asset to bring it back down to the 50% level, and then reinvesting the proceeds from that 5% into the other holdings in the targeted mix. Again, no additional money was added to the portfolio, nor did the market value of the portfolio grow immediately following the reinvestment. But the book value will have increased… the sell and buy do not offset each other perfectly.

The reason for this approach is simply to track taxable capital gains. When distributions or dividends are declared and/or a sale is made, if the money is outside your RRSP, taxes are owed at year-end. Then, if the money is reinvested in the same and/or other holdings, the book value of those holdings must increase so that you do not have to pay tax on the gains twice. In other words, the book value is intended to help track the gains of a specific holding - NOT the gains of the overall portfolio.

So my advice to you, if you are scoring your portfolio performance at home, is to keep an eye on the market value, and watch how that number moves up or down. Comparing it to the book value will only cause confusion.