The market value and book value of your investment is $50,000. You are unhappy because you believe that you have not made a profit. The problem? There is a very high probability that this assumption is incorrect.
For example, let’s assume Bob purchases $50,000 of a mutual fund at the beginning of the year. Over the next year, the market value rises to $55,000. In December, the mutual fund pays a distribution worth $5000, which is reinvested. Since reinvested distributions are treated as new purchases, Bob’s new book value changes to $55,000 ($50,000 original book value plus $5,000 worth of new units). The value per unit is adjusted downward resulting in the market value remaining at $55,000. Bob, understandably confused, mistakenly believes that he has not made any money on this investment when he has in fact earned $5000.
In another instance, let’s assume Bob purchases $50,000 of an ETF or dividend paying stock that has a 5% yield. A year later, the market and book value of this investment is still $50,000, and Bob feels that he has not made a profit. This is incorrect since it ignores the $2,500 (5% of $50,000) of income paid into Bob’s account.
In simple terms, this means that comparing the book to market value will almost always understate the real profit you have earned. If you have any questions on this and how it affects you, please do not hesitate to get in touch.
This is assuming the distributions are reinvested, which is not always the case