Investment Company and Variable Contracts Products Representative (Series 6)Practice Exam

What components make up the cost basis of a mutual fund client?

1. Only the original investment

2. Original investment plus reinvested dividends and capital gains

3. The total amount invested in the market

4. All withdrawals made from the fund

The correct answer is: Original investment plus reinvested dividends and capital gains

The cost basis of a mutual fund client is crucial for understanding the total investment in the fund, which impacts tax liability upon selling shares. The correct option describes the components of the cost basis accurately. When determining the cost basis for a mutual fund, it includes not only the original investment made by the client but also any reinvested dividends and capital gains. When dividends or capital gains distributions are reinvested in the fund, they buy additional shares, increasing the total investment and thus the cost basis. This comprehensive view ensures that when shares are ultimately sold, the calculation of gain or loss can be accurately assessed based on the entirety of funds invested over time. Other options do not adequately capture the total investment perspective. Focusing only on the original investment ignores the significant impact of reinvested earnings, which can alter the actual financial picture of the investment. Considering only the total amount invested in the market overlooks specific components essential for cost basis calculation. Finally, incorporating all withdrawals would actually reduce the cost basis rather than define it, as they reflect the withdrawal of funds rather than capital being invested. Hence, the correct answer encompasses the complete picture of a client’s investments in a mutual fund, leading to an accurate calculation of gains or losses for tax purposes.