Whether you invest for retirement, personal income or business, risk is an inherent element of investing. Although you hope your investments will earn you money, they can cause financial loss. As an investor, you likely will experience both realized and unrealized gains and losses, which have different effects on your investments.
Realized gains and losses are differences in the principal amount of your investment, or the amount you have paid in, that you actually have incurred. For example, if you purchase an investment real estate property for $200,000 and sell it for $300,000, you have a realized gain of $100,000. Unrealized gains and losses are differences in your principal that you have not yet incurred. For example, if a $200,000 real estate investment property has appreciated to a value of $300,000, but you have not yet sold the property, you have an unrealized investment gain of $100,000.
Potential for Change
Because realized gains and losses are those which you already have incurred, there is no future upside or downside that can affect the gains or losses. If you sell an investment for a $20,000 loss, you no longer have the potential to recover the loss through that investment. Conversely, unrealized gains and losses can change over time. If market conditions cause a real estate investment property to depreciate, which results in an unrealized loss, holding onto the property until conditions improve could allow you to recover the loss.
Realized investment gains typically are subject to taxation as capital gains, because you have received the gains as income. Realized losses usually can be used to offset realized gains to decrease tax liability. Unrealized gains, however, are not subject to taxation, and unrealized losses cannot be used to offset realized taxable gains.
Realized gains and losses have an immediate effect on your investment principal as soon as you sell the investment. The effect of an unrealized gain or loss depends on the amount of time you have available before you sell the investment. For example, if you are investing for retirement and have 35 years until you retire, an unrealized loss might not significantly threaten your ability to meet your investment goals. However, if you plan to retire in one year, an unrealized loss could dramatically affect your retirement income.
- "Investing for Dummies"; Eric Tyson
- Vanguard: More About Realized and Unrealized Gains and Losses