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The Difference Between Book Value and Market Value

The Difference Between Book Value and Market Value

There have never been more investment options available to investors.  The marketing material usually tells you that all these options are supposed to make things much simpler (and usually cheaper), and yet investing has never felt so complicated.

In spite of all these available options, the traditional mutual fund remains a resolute and stalwart performer that, when used appropriately within a well-constructed investment portfolio, can be utilized to effectively create a pension plan worthy of any portfolio manager.

Some of the main advantages of mutual funds are as follows:

  • Accessibility to professional money managers,
  • The ability to diversify across broad markets and sector categories with low minimum investment requirements,
  • The simplicity and flexibility to switch investments when necessary, to make systematic deposits or withdrawals, and to have distributions reinvested automatically as they are received.

One of the main challenges that investors tend to have with mutual funds; however, is the understanding of how performance is calculated.  Our goal with today’s article is to help you understand how to determine your overall performance on the mutual fund securities that you own.

First of all, let’s start with a statement.  Below you’ll see a sample statement for Manulife securities.  When looking at performance, it’s common (and understandable) that investors will look at the difference between the market value of their investment and the book value (or ‘book cost’) to assess how well an investment has been performing.  

Unfortunately, this information doesn’t tell the whole story.  The book value does represent the original amount that you invested when you purchased the fund; however, it also includes transactions that take place during the period that you hold the fund.  To help explain what we mean by this, let’s look at an example of a mutual fund that was purchased at the beginning of this year (2019).

Imagine that on January 2nd, an investment of $40,000 was made into the Renaissance Flexible Yield Fund in a calculation that is shown in the analysis below.  The unit price at that time was $9.43 per unit and this allowed the investor to purchase 4,241.78 units (4241.78 units * $9.43 = $40,000).  At Manulife, we call the $40,000 that was invested net invested capital.  At this point of initial purchase, the fund’s book value and market value are also equal to the net invested capital.  

Throughout the year, the Renaissance Flexible Yield Fund pays regular monthly distributions to account for any income and gains generated by the portfolio manager.   Looking at the first distribution on January 31st, the fund pays 0.031 per unit to each investor.   This amounts to $131.50 of additional dollars that will be reinvested into additional units (4241.78 units * $0.031 = $131.50).  The market value per unit on January 31st is $9.55, which means $131.50 will buy an additional 13.77 units.  As a result of this purchase, the investor now has 4255.55 units.

Following the purchase, the new book value is now $40,131.50, while the market value is $40,640.51 (4255.55 * $9.55).  Note:  net invested capital is still $40,000 (i.e. it hasn’t changed).

If we then proceed to the most recent statement date of October 31st, the fund’s book value has become $41,334.21.  This is a result of the consistent monthly distributions that have taken place throughout the year.  The additional units that those distributions have purchased have taken the unit value from 4,241.78 on January 2nd to 4,380.44 on October 31st.  With a Net Asset Value (or price per unit) of $9.60, that results in a market value of $42,052.26 (4,380.44 * $9.60).

Given, the analysis above, how has the fund performed?  When looking at their October statement, the investor will see a book value of $41,334.21 and a market value of $42,052.26.  As a result, it would be easy to draw the conclusion that the fund has only provided a rate of return of 1.74%; however, that wouldn’t be correct.   The reason being; the calculation implies that the amount of money that the investor has put into the fund is $41,334.21 when in fact their net invested capital is still only the initial $40,000 that they deposited on January 2nd.

Taking the net invested capital into consideration, the fund has actually returned 5.13% since the beginning of the year, which is a noticeable difference.   The two calculations can be summarized as follows:

                Incorrect Performance Calculation:         ($42,052.26-$41,334.21)/$41,334.21 = 1.74%

                Correct Performance Calculation:            ($42,052.26-$40,000.00)/$40,000.00 = 5.13%

With the above analysis in mind, why do investment companies continue to show a mutual fund’s book value instead of net invested capital on their statements?   The reason is that the book value is still a really useful and important number.

From a taxation point of view, the book value is also called the adjusted cost base (ACB) because it represents the total of all purchases (both net invested capital and reinvested distributions) made into the fund.  This book value or ACB, therefore becomes an important number if you hold your fund within a taxable non-registered account.  When you ultimately sell the fund at some point in the future, capital gains (or losses) will be calculated by subtracting the book value from the market value.  Distributions that you’ve previously received that were added to your book value will have already been taxed and you will have received the details through the t-slips that you receive from Manulife at tax time (Note:   this doesn’t apply to RRSPs, RRIFs, TFSAs or other registered accounts).

It’s important to us that you understand how your investments are doing and we hope this article helps to explain the important difference between the book cost that you see on your statements and your net invested capital.  If you’d like further information, or if you’re unclear on how your investments have done since you purchased them, we’d like to review them with you.  Please call us at (780) 426-2400, or e-mail us at gary.koss@manulifesecurities.ca  to schedule an appointment.

For illustration purposes only.  This publication is solely the work of Gary & Lexy Koss for the private information of his or her clients. Although the authors are Manulife Securities Advisors, he/she is not a financial analyst at Manulife Securities Investment Services Inc(“Manulife Securities”). This is not an official publication of Manulife Securities. The views, opinions and recommendations are those of the author alone and they may not necessarily be those of Manulife Securities. This publication is not an offer to sell or a solicitation of an offer to buy any securities. This publication is not meant to provide legal, accounting or account advice. As each situation is different, you should seek advice based on your specific circumstances. Please call to arrange for an appointment. The information contained herein was obtained from sources believed to be reliable; however, no representation or warranty, express or implied, is made by the writer, Manulife Securities or any other person as to its accuracy, completeness or correctness.

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