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Let's say I bought 1 share in a Vanguard mutual fund each year for 10 years. Its price started at $1 and went up by exactly $1 each year, so the price of the latest share bought is $10.

The average cost basis for one share is then $5.5.

If I ask Vanguard to sell 5 of them at average cost basis, does it calculate the cost basis of shares sold at $5.5, the average cost of ALL shares? Or is the average cost basis based on the shares actually sold?

e.g. if it decides to sell lots 1-5, then the average cost basis of just those 5 shares is $3.

What is the cost basis of shares sold in that case -- $3 or $5.5?

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    Personally I would use FIFO. – user9722 Apr 14 '15 at 22:08
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Your shares are just a pool. You don't identify individual shares that sell. For example if you have 10 shares, you have 10 purchase prices. But they're all worth the same at the time you sell them. You will pick the purchase prices from those 10 that make sense for your situation to use as your cost basis.

Common strategies are, First-in-first-out, Last-in-first-out, Average (across the entire position, not just the shares sold), or Cherry picked (not recommended). You need to use the same method for as long as you have the position. If you sell everything and buy some more, you can pick a different method.

Your brokerage likely does this for you, possibly allowing you to choose your method. (They may just make a choice for you - it's easier to design and maintain their software that way.) As long as you've bought and sold the shares through the same brokerage, the cost basis numbers are usually accurate. If you transfer your assets to another brokerage, you'll need to get your cost basis data from your old account before the transfer. Some send it along as part of the transfer, some do not.

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If I understand you right, you are asking about two incompatible things. If you choose to sell at average cost basis, you don't get to specify which lots you are selling. If, on the other hand, you do specify which lots you are selling, then you don't use average cost basis, but rather the actual cost basis of those particular lots (i.e., the actual prices you paid for those specific shares when you bought them).

So yes, if you sell 5 shares and choose to use average cost basis, it will use the average across all shares. The point of using this method is that you don't have to worry about which shares are actually sold. If you want to know/care which individual shares are sold, you won't use average cost basis.

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You can choose how to calculate basis. You can use FIFO, LIFO, specific lot (i.e.: each time you sell you specify the exact position out of the ones you have that you're closing), or you can choose average share price.

Average share price can only be used for mutual funds (which is what you're asking about), and you must use it every time for the fund in question once selected (as opposed to other methods which you can select differently on each transaction).

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