How to Fix Your Broken Records

Barbara knows exactly how much she paid for 100 shares of stock way back in 1962. It’s what’s happened since then that makes her fuzzy.

That’s because she’s been reinvesting dividends for the last 26 years. She never stopped to calculate how much extra money that amounted to. But now that she’s considering selling the stock, she’s in a quandary.

Going through 26 years of investment records to tabulate her total investment, including reinvested dividends, will be a horrible--maybe even impossible--job. But if she doesn’t do it, she may pay too much in tax.

Her story is by no means unique. Investment professionals maintain that record keeping is one of the most important and most widely ignored steps in wise investing. Good records help you monitor your portfolio and help you determine when to buy and sell. They’re also pivotal when you’re determining how much tax you have to pay. And they can signal whether something is wrong with the way your broker or other financial advisors are handling your account.

“We try to explain to people that record keeping is the financial equivalent of getting an annual physical,” says Richard A. Armellini, vice president and branch manager at Fidelity Investments in Century City. “It helps you keep with up with fees and performance, and it can save you a fortune if you [pay by the hour to] have your tax return professionally prepared.”

Yet many investors fail to do it, having never set up an adequate system. Without a system, the process is ponderous. But it doesn’t need to be. If you start early and do it right, keeping good records will save you time and money.

So how do you do it?

Ellen Norris Gruber, author of “The Personal Finance Kit” and co-owner of a Burlingame, Calif., company called Go Get Organized, suggests that you buy a large three-ring binder, a three-hole punch and some colored binder tabs. That will set you back $15 to $20, but these materials can serve as a basis for your investment records for decades, she says.

Next, divide the binder into sections for specific investments or types of accounts.

Some people, particularly those with large, diverse portfolios that have actively traded investments, set their records up by date instead, keeping track of trades on a month-by-month basis. But an investment-by-investment approach works nicely if you have a manageable number of investments that hold for long periods.

With taxable accounts, you should label each segment with the name of the investment--”XYZ Co.” for instance, or “XYZ mutual fund.” If you have tax-favored retirement accounts such as 401(k)s, IRAs or Keoghs, you may want to label them by the name of the account instead. You might have a section called “John’s 401(k)” or “Mary’s IRA,” for example.

Why label the section with the IRA moniker rather than the investments held in it? Because one of the primary reasons that you keep these records is to determine your taxable gains and losses. Investments held through a retirement account will all have the same tax properties. You can sell IBM at a profit and buy a new stock--or keep the profit in cash--and as long as the money stays in the IRA, there is no tax consequence. The only time you’ll have to determine your tax bill when selling investments in a tax-deferred IRA, Keogh or 401(k) is when you pull the money out of the account to spend it. Then the tax will be assessed on the entire amount--principal, interest and capital gains.

With other investments, taxes are due in any year that you collect income or sell them at a profit. On the other hand, you can generate a capital loss if you sell when the stock price drops below your purchase price, which can offset other gains. You cannot deduct capital losses in tax-deferred accounts from capital gains or ordinary income.

The third step is to create a page that summarizes that particular investment. (See work sheet, this page.) This summary will include how much you initially invested, your cost of investment--such as brokerage fees--and any subsequent investments you’ve made in that stock, bond or mutual fund. The initial costs (including brokerage fees or mutual fund “loads” and sales commissions) as well as the amounts of subsequent investments will all determine your tax basis--the total cost of the investment--when it comes time to determine your taxable gain when you sell. Those who fail to keep track of the brokerage fees and reinvested dividends, or of the initial cost of the stock, may pay too much tax.

“When you sell shares, the custodian or transfer agent will send both you and the IRS a 1099b showing the proceeds from the sale,” says Matt Luoma, vice president of tax and accounting at Janus Mutual Funds in Denver. “Barring information to the contrary, the IRS assumes that the entire amount is profit. If you can’t establish your cost basis in the investment, you end up paying tax needlessly.”

After you’ve got your system set up, all you need to do is file the periodic account statements behind the summary page for each investment. It’s wise to briefly review each statement when it comes in to make sure there are no errors or other discrepancies.

Once a year, you should update your summary page to indicate additional investments or sales and taxable profits. The summary page serves as a quick-reference guide for you or your tax accountant when you want to determine your tax obligation for the year. It should also give you a good idea of how your individual investments and your portfolio as a whole are faring.

Can you delete a section when you sell an investment? Not immediately. You should save those records for at least four years, just in case you’re audited by federal or state tax authorities, Gruber adds.

What if you’re in Barbara’s situation--you’ve been investing for years without keeping good records and are now uncertain about where you stand?

You could estimate and hope you aren’t audited, of course. If you are going to do it right, though, ask your broker, mutual fund company or investment advisor to help you reconstruct your account history. In some cases, you’ll be charged a fee for copies of old account statements or for the advisor’s time. If the account isn’t terribly old, the fees are likely to be modest and the job will be manageable. But the longer you wait, the more difficult it becomes.

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Set Your Own Record

If you start early and do it regularly, keeping good investment records is a snap. Here’s a sample work sheet. You would use one for each security you own.

Investment:

Per-share purchase price: $

Date purchased:

Number of shares:

Total initial investment: $

Brokerage/trading fees: $

Total invested, initial year: $

Subsequent investments:

Year:

Additional amount invested: $

Shares acquired / new total: /

Reinvested dividends: $

Brokerage/trading fees: $

Total invested to date: $

Year:

Additional investment: $

Shares acquired / new total: /

Reinvested dividends: $

Brokerage/trading fees: $

Total invested to date: $

Year:

Additional investment: $

Shares acquired / new total: /

Reinvested dividends: $

Brokerage/trading fees: $

Total invested to date: $