When you invest in stock, your cost basis is the price you paid to buy it. The difference between your cost basis and the current stock price is your amount of profit or loss. Focusing on cost basis can help you make decisions about if you should buy, sell, or hold one of your stocks.
This video shares a few cost basis hacks you can use to maximize your investing ROI over the long term. Using your cost basis to evaluate a stock price is an important skill to develop, particularly if you hold multiple stocks as a long term investor.
This post originally appeared as a video on the 40 Finance YouTube Channel
What is cost basis? What does it mean? And for that, we'll go to Investopedia right to their dictionary area. You see the, the takeaways box, their cost basis is the original price that an asset was acquired for tax purposes. They're saying that, you know, most of the time cost basis comes into play. When it comes to paying taxes. We're not really going to talk about the tax part too much, but the bottom line here is it was the original price you paid for a stock capital gains are computed by calculating the difference between the sale price to the cost basis. So whatever your cost basis was for Tesla, let's say it was a thousand dollars and you sold it for $2,000.
The difference between the two is what the government is going to be looking for. And another important thing that you should dig into on your own as you March, along in the investing journey is several accounting methods exist to adjust the cost basis. So that is more favorable, but be careful to follow IRS guideline, to make the short and sweet, you know, do your own research. But basically if you sold a portion of your shares, uh, you can set it up in your tax return so that you sold, uh, the oldest shares, uh, so to speak or the newest, if that's to your advantage. But if you sell your whole lot, then you ha you sorta have less opportunity. So the crux of all that is cost basis is what you, as an individual paid for a stock on the day that you bought it.
And that is the price that ultimately determines how much money your investment will return over time. I use the Tesla a minute ago. It's always interesting to me, cause you'll see a tweet or somebody say, you know, Tesla's over $2,000, hurray, and everybody's replying, you know, yay and rocket ship and all this stuff. I always wonder how many of those investors got in a way in the beginning? Right? So if I was at $300, $700, or $900 then that's exciting. How many of the people who are cheering got in at 1700, and have less to cheer for? Whenever I see people cheering for a stock, I'm always thinking from a cost basis, point of view, what does it mean to me? And while it's important to take a bigger view of a stock across the longer term, understanding what your goal is based on, where you began with the stock makes a huge difference in how you manage your investments.
I could be in here looking at stock X and saying, wow, plus 36%, this thing's on fire. I'm going to dump more into it. I tend to look at it a little bit with a contrarian view. And I would say, wow, up 36%, how much higher can it go? Then I would look down and say, look at the Z. Z was not moved up nearly as much. Let's dig into Z. The opportunity over the longterm might be together. Get more Z while the price is down, knowing that we're in it for the long haul and Z will eventually have their day when the market conditions are right.
Yes. That assumes you have a similar price target for all three stocks, but you get the drift here using cost basis across multiple stocks can really influence your investing decisions or at least give you an option that you maybe did not think of. Alright, so the bottom line here is cost basis is your investing grade card, no matter what a stock price is, if you're a shareholder, you know, it's great to see things go up. It sucks to things to see things go down, but only, you know, what your cost basis is Tesla to keep picking on them could drop $500 tomorrow just for the heck of it, right? If your cost basis on Tesla was $200, the 500 stings, but you really don't care. Right? On the flip side, the guy who bought Tesla at $1,700 sees it dip from 2000 to hundred. Now he or she is in the red.
So that's a pretty monstrous dip for them. And the grade card of those two investors is quite different. The guy who bought at $208 is doing fine after the loss. He still gets an A+ compared to the guy who bought in at $1700 thinking it's never going to stop going up for the rest of the time. Right now, he's got an F. Only time time will tell from a cost basis standpoint. This is really important that you understand your cost basis. You should always have a mental concept of where it stands. Sometimes a news headline will come out and the cost basis won't come into play and you'll be like, this is just monstrous. I'm piling it. Now, if it's a regular run of the mill market day, though, and you're ready to do sort of your monthly investing or your drip investing, whenever you want to call it, you might start looking at those stocks where the cost basis, this is closer to the current price, or perhaps even under to see, yeah, if you can shave off some of the loss and get prepared for the longterm at the end of the day, cost basis influences quite a few of my investing decisions.