The annual total returns of my portfolio (blue bars) and its benchmark index (black bars) are plotted as percentage changes in total market value.
The annual cost basis of my investments varied according to the net cash flow from dividends, reinvested dividends, capital gains, capital losses, and reinvested capital gains. The net cash flow amounted to a realized return that was either a ‘real profit’ when earned from dividends and capital gains or a ‘real loss’ when investments were sold below cost basis. The following bar graph identifies annual changes in cost basis associated with the realized return:
The realized return (brown bar) was unevenly distributed among stocks (orange bar), other investments (gray bar), and residual cash (green bar).
- 2008, the sale of mutual funds (gray bar) and purchase of stocks produced a 37% ‘real loss’.
- 2009, most of the 18% ‘real profit’ was stored as residual cash.
- 2010-2011, a ‘zero sum game’ of stock losses offset by ETF gains.
- 2012, a 12% ‘real profit’ was distributed among the ETFs and residual cash despite losses from stocks.
Any spread between the market value and cost basis is reported by the brokerage firm as an unrealized return. Only an investment, not a cash balance, produces an unrealized return. And though the unrealized return is merely a calculated number, it’s important for these reasons:
- The unrealized return is a ‘potential profit’ when the market value exceeds cost basis and a ‘potential loss’ when the market value falls below cost basis. These outcomes can evoke feelings of confidence or discouragement.
- The unrealized return becomes a taxable realized return when the investment is sold (unless the investment is held in a tax-deferred brokerage account).
The following bar graph shows the additive contributions of stocks (gold bar) and other investments (gray bar) to the annual unrealized return (blue bar):
In my portfolio, stocks were the prime sources of potential profit or loss in every year except 2010. ETFs (gray bars) were the more conservative investment. Most of the time my portfolio operated with a potential loss.