Review: Cost Basis Reduction

Cost Basis, or the original cost per unit of your investment is important both when calculating taxes and return on your investment. There are many strategies used to reduce your basis, thus potentially reducing taxes or boosting profits or both.

Today I wish to review one common method of cost basis reduction, which is useful to investors with a long investment horizon, they are otherwise known as long term investors. This method is called intermittent purchase. The way it works is that after your initial purchase of an investment, you intermittently buy additional units whenever the price dips below your purchase price.

This is of course predicated upon two things;
One your continued belief in the long term viability and success of the project, and...
Two the availability of disposable income, I.e. funds you can afford to lose such as money you would spend on non-necessities like designer coffees, expensive meals, etc

The math works like this:
You buy 10 units of Steem for $4.00 per unit.
Total investment $40.00.
Total investment divided by number of units is 40/10 or $4.00.

If the price rises to $5.00 and you sell your return on investment is;
Profit $1.00
Profit/Cost or roughly
1$/4$ or 25%.

Now let’s reduce your basis and increase you return on investment.

One month later on a dip or drop in price, you buy 10 units of Steem for $3.5
Total second investment $35.00.
Now total investment is $40.0 plus $35.00 or $75.00.
Total number of units is now 20.
Your new cost basis is $75.00/20 units or $3.75 per unit.

In this example your cost basis has been reduced from $4.00 to $3.75.
If the price rises to $5.00 and you sell, your profit is now $1.25 per unit.
1.25$/3.75$ is 33%.
In this example you have increased your profits from 25% to 33% with this additional profit being due to your willingness to buy on a dip or drop in price.

This strategy also allows you to increase your multiple.
Multiple is the ratio of profit per unit, which is an important term to understand when considering investing in a large item which can double or a small item which could triple. In the first Example your profit was 25%, so your multiple was 1 plus 0.25 or 1.25.
In the second Example your profit was 33%, so your multiple was 1 plus 0.33 or 1.33.
We will talk more about profit multiple in a future article.

Summary:
Basis reduction strategies are common in investing and buying additional units on dips is a common and easy to understand method. I actively use this method to purchase things I believe in like Apple, Amazon and Steem. I have increased the size of my investment in Steem while reducing my basis. It’s import to realize and understand that the value of the unit purchased goes down with these additional purchases, so you must have faith in the eventual rise in price, with an eye towards future profits or increased dividend. If you have questions or comments about your experiences please comment below.

✍🏼 By Shortsegments.