|Adjusted Cost Base for Canadians|
|See also: ACB Calculator|
You bought 100 units of some fund or stock, in 1996.|
In 1997, you bought another 100 units.
In 1998, you sold 100 units and, assuming the investment has increased in value, you pay capital gains.
Aaah, but on which 100 units? The 1996 units? The 1997 units?
In fact, for purposes of computing your capital gains, it's assumed that the 100 units you're selling were bought at some kind of average purchase price, or, to put it differently, at the Adjusted Cost Base (ACB).
What's the ACB? It's the ratio: Cost of Purchases/Total Units Held.
The initial Cost of Purchases is just the initial out-of-pocket
monies it cost to make your first investment, including any commissions.
Let's call this C(1)
Suppose you later buy more units, say u(2) units.
Note 1: Reinvesting dividends/distributions counts as new purchases!
After n such purchases we have:
Now comes the interesting part; you sell some units.
We know what the Total Units Held becomes after this sale of u units,
And the Cost of Purchases? What becomes of it?
Conclusion? The Cost of Purchases is decreased, after a sale of u units, as though these units were purchased at a cost equal to the current Adjusted Cost Base. See? I told you!
In fact, if you sell 10% of your units then the number of units gets reduced by 10% and so does the Cost of Purchases ... so their ratio remains unchanged! To see this, we write:
U' = U - u = U(1-u/U)
which says the Total Units Held has been reduced by a
(because of the sale of u units).
In order that the ACB remain unchanged the
Cost of Purchases
must be reduced by the same factor. That gives:
Because both C and U get reduced by some positive factor when selling, neither can become negative, so ACB = C/U is always a positive number (unless you sell more units than you own).
C = Cost of Purchases
We've spent $5,000 and hold 416.67 units and our ACB is currently $12.000 and now:
We buy 400 units at $12.50/unit (that's 400*12.5=$5000)
NEW (cumulative) cost of purchases is $5,000 + $5000 = $10,000
We've spent $10,165.28 and hold 830.77 units and our ACB is currently $12.236 and now:
We sell 300 units at $15/unit (that's 300*15=$4500)
and there's a 3% transaction cost so we're left with .97*4500 = $4365.00
NEW (cumulative) cost of purchases is 10,165.28 - 300*12.236 = $6494.49 (subtract 300 units at the old ACB)
If you hold U units in your portfolio, and your out-of-pocket cost to achieve this portfolio is $A (made up of the Sum of Investments minus the Sum of Withdrawals), then A/U is your Cost per Unit. The ACB is not to be confused with your Cost per Unit. ACB cannot be negative whereas your Cost per Unit can be negative.
The Cost per Unit can also be regarded as your Break Even price (ignoring commissions). If you sold your current units at this Cost per Unit, you'd recoup all your money. If the Cost per Unit is negative, it means that the stock price could go to $0 and you'd still be ahead!
Suppose your portfolio has 50 units which are currently worth, say, $10 and your Adjusted Cost Base is $5. You might think you're making money! That's not necessarily true. It may be that you bought 1000 units at $5 (so your ACB is $5). Then you sold 950 units at $1 - losing a bundle of money - and now, the 50 remaining units in your portfolio are worth $10 each. However, you're still in the red. Nevertheless, since the ACB didn't change when you sold units, it's still $5!
On the other hand, had you sold the 950 units at $100 (instead of $1, thereby making a bundle of money) then you've already made more than your initial investment ... your Cost per Unit is now negative (tho' your ACB is still $5).