What Is the Difference Between a Realized & Unrealized Loss?

by Gregory Gambone Google

    There are no guarantees in the stock market, and your account balance fluctuates as the securities in your portfolio react to market conditions. The value of your account will rise and fall as long as it contains variable investments, and in this situation you should understand the difference between realized and unrealized losses. Both types of losses have an effect on your portfolio and trading decisions. FXStreet.com explains: "Understanding the impact of realized and unrealized returns is something key in the development of both money management schemes and trading systems."

    Unrealized losses in your investment account are decreases in the value of the securities you own that take the stock below your original purchase price, called your cost basis. When the prices of your stocks, bonds, mutual funds or other holdings decline, the overall value of your account decreases as well. However, since you still own the securities and no transaction has occurred, their value may still fluctuate. This is sometimes called a paper loss.

    Decreases in the value of your investments become realized losses when you sell those holdings for less than what you originally paid to acquire them. Any losses you experience may still be reversed until you sell those investments. Once you sell a security, any losses and price changes become fixed.

    The IRS allows you to deduct realized capital losses in non-retirement accounts. Losses are offset by gains, and the maximum annual deduction was $3,000 as of July 2012. If your realized investment losses exceed this threshold, remaining amounts may be carried over indefinitely and deducted on future income tax returns.

    Selling an investment when its value has dropped below your cost basis guarantees you will lose money. By selling and converting that security to cash, you give up the potential for future market gains that might have positively impacted that particular investment and erased the loss. You must carefully consider your portfolio and re-examine the characteristics of that investment that led you to buy it. If you believe it's better to cut your losses before the security's value drops further, take the time to analyze your investment strategy and make sure your entire portfolio is suitable for your time horizon and risk tolerance.

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    About the Author

    Gregory Gambone is senior vice president of a small New Jersey insurance brokerage. His expertise is insurance and employee benefits. He has been writing since 1997. Gambone released his first book, "Financial Planning Basics," in 2007 and continues to work on his next industry publication. He earned a Bachelor of Science in psychology from Fairleigh Dickinson University.

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