A:

When buying and selling assets for profit, it is important for investors to differentiate between realized profits and gains, and unrealized or so-called "paper profits".

Simply put, realized profits are gains that have been converted into cash. In order words, for you to realize profits from an investment you've made, you must receive cash and not simply witness the market price of your asset increase without selling. For example, if you owned 1,000 common shares of XYZ Corporation, and the firm issued a cash dividend of $0.50 per share, you would realize a profit of $500 from your investment. This is a realized profit because you have received the actual cash, which cannot be lost due to changes in the marketplace.

Similarly, let's say you purchased your 1,000 XYZ shares at $10 per share, for a total investment of $10,000. If XYZ Corp. were presently trading on the market for $15 per share and you sold all of your 1,000 shares on the open market at $15, you would realize a gain of $5,000 on your investment ($15,000 - $10,000).

Now, suppose that XYZ Corp.'s shares were trading at $15, but you believed they were fairly valued at $20 per share, and therefore, you were not willing to sell at $15. Because you would still be holding on to all of your 1,000 shares, you would have an unrealized, or "paper", profit of $5,000. Of course, if you have not closed out of your position and realized your gain, you could still lose some, or all, of your profits - and your principal as well.

On the other hand, because you have not realized your profit, you are not required to claim the gain as income; thus, by holding your shares instead of selling, you can potentially defer taxable income for a year (or many). Of course, the reverse is true for losses - realized losses can usually be claimed by investors as capital losses, offsetting other capital gains, while paper losses can not.

To learn more about profit realization and its implications for investors, check out Selling Losing Securities For A Tax Advantage, A Long-Term Mindset Meets Dreaded Capital-Gains Tax and Tax Tips For The Individual Investor.

RELATED FAQS
  1. What is a derivative?

    A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset, ... Read Full Answer >>
  2. How do I file taxes for income from foreign sources?

    If you are a U.S. citizen or resident alien, your income (except for amounts exempt under federal law), including that which ... Read Full Answer >>
  3. How liquid are Vanguard mutual funds?

    The Vanguard mutual fund family is one of the largest and most well-recognized fund family in the financial industry. Its ... Read Full Answer >>
  4. What do states do with unclaimed property?

    Unclaimed property refers to personal accounts in financial institutions or companies that have had no activity and whose ... Read Full Answer >>
  5. Do financial advisors charge VATs?

    The Personal Finance Society (PFS) and with Her Majesty's Revenue and Customs (HMRC) have outlined when a value-added tax ... Read Full Answer >>
  6. How do mutual funds work in India?

    Mutual funds in India work in much the same way as mutual funds in the United States. Like their American counterparts, Indian ... Read Full Answer >>
Related Articles
  1. Mutual Funds & ETFs

    ETFs Can Be Safe Investments, If Used Correctly

    Learn about how ETFs can be a safe investment option if you know which funds to choose, including the basics of both indexed and leveraged ETFs.
  2. Mutual Funds & ETFs

    3 PIMCO Funds Rated 5 Stars by Morningstar

    Learn about three fixed income mutual funds managed by Pacific Investment Management Company (PIMCO) that have received five-star overall ratings from Morningstar.
  3. Mutual Funds & ETFs

    3 Invesco Funds Rated 5 Stars by Morningstar

    Learn about the top three mutual funds administered and managed by Invesco Ltd. that have received a five-star overall rating from Morningstar.
  4. Mutual Funds & ETFs

    The Top 5 Large Cap Core ETFs for 2016 (VUG, SPLV)

    Look out for these five ETFs in 2016, and learn why investors should closely watch how the Federal Reserve moves heading into the new year.
  5. Taxes

    Why People Renounce Their U.S Citizenship

    This year, the highest number of Americans ever took the irrevocable step of giving up their citizenship. Here's why.
  6. Fundamental Analysis

    The 3 Best Investments When Bull Markets Slow Down

    Find out why no bull market lasts forever, and why investors should shift their assets away from growth and toward dividends when stocks slow down.
  7. Mutual Funds & ETFs

    Top 3 PIMCO Funds for Retirement Diversification in 2016

    Explore analyses of the top three PIMCO funds for 2016 and learn how these funds can be used to create a diversified retirement portfolio.
  8. Stock Analysis

    Forest Laboratories: An Activist Investment Analysis

    Find out how patience and perseverance paid off big-time for billionaire activist Carl Icahn during his four-year fight with Forest Laboratories.
  9. Mutual Funds & ETFs

    The 4 Best Lord Abbett Mutual Funds

    Discover the four best mutual funds administered and managed by Lord, Abbett & Co., LLC that offer investors a wide variety of investment strategies.
  10. Stock Analysis

    Tribune Media: An Activist Investment Analysis (TRCO)

    Learn more about the breakup of Tribune Company, once a powerful newspaper and broadcasting giant, and the role of activist investor Cliff Robbins.
RELATED TERMS
  1. Share Repurchase

    A program by which a company buys back its own shares from the ...
  2. Issued Shares

    The number of authorized shares that is sold to and held by the ...
  3. Taxes

    An involuntary fee levied on corporations or individuals that ...
  4. Record Date

    The cut-off date established by a company in order to determine ...
  5. Outstanding Shares

    A company's stock currently held by all its shareholders, including ...
  6. Wealth Management

    A high-level professional service that combines financial/investment ...
Hot Definitions
  1. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
  2. Presidential Election Cycle (Theory)

    A theory developed by Yale Hirsch that states that U.S. stock markets are weakest in the year following the election of a ...
  3. Super Bowl Indicator

    An indicator based on the belief that a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in ...
  4. Flight To Quality

    The action of investors moving their capital away from riskier investments to the safest possible investment vehicles. This ...
  5. Discouraged Worker

    A person who is eligible for employment and is able to work, but is currently unemployed and has not attempted to find employment ...
  6. Ponzimonium

    After Bernard Madoff's $65 billion Ponzi scheme was revealed, many new (smaller-scale) Ponzi schemers became exposed. Ponzimonium ...
Trading Center