20240304 Old Habits Die Hard

A Bad Habit Which Refuses to Die

Bad habits can sometimes be hard to break. One bad habit in investment analysis is using cost basis to judge performance. The point of this note is to explain why it is a bad idea and a habit in need of breaking.

It is natural to wonder, how are my investments doing? The question might come up as you periodically review your accounts. It seems intuitive that you could simply compare today’s value of any investment with its cost basis to assess how the investment is performing.

The problem with this intuitive approach is the treatment of income, dividends, and capital gains. Cost basis is not designed to track the total return of any investment. If you elect to reinvest dividends, for example, then every reinvested dividend increases your cost basis. If you invest in a fund that pays monthly dividends and you elect to reinvest, then your cost basis increases every month by the amount of the dividend. The higher the dividend and the longer you hold it, the greater the impact.

If you elect not to reinvest dividends, your cost basis completely ignores the dividends. It is as if they did not exist. For many investments, dividends are a significant portion of total return over time. Therefore, whether you elect to reinvest dividends or not, the habit of comparing today’s value of your investment to cost basis does not accurately reflect the total return of your investment.

An apparent workaround for this problem would be to review a price chart of your holding from a third-party online resource. Unfortunately, some tools, including Yahoo! Finance charts, often ignore the impact of dividends, making them equally misleading in judging performance. Here is an example. Suppose that five years ago, you invested in the Pimco Income Fund (ticker PIMIX), which is a fund that pays regular monthly dividends. The 5-year price chart at Yahoo! Finance showed the March 4th price at $10.55, below the price five years ago. The erroneous implication is that PIMIX has been underwater over the last five years. 

An alternative source of information is StockCharts.com, an online resource that does not ignore dividends. Here, we see the value of PIMIX (including dividends) has oscillated up and down over the past five years and is now near its peak value over the period, up 16.7% since late February 2019.

In my view, the lessons to learn here are simple. Dividends can have a significant impact on the total return an investor receives over time. However, some habits for judging the performance of investments ignore dividends. These habits are misleading. The good news is there are tools available that account for dividends and avoid these misleading pitfalls. StockCharts.com and Koyfin.com are two online tools that offer performance charts that include dividends. Accurate assessments are readily available online, but we must first break the bad habit of looking at cost basis to judge how our investments are doing. 

Mike Masters