FIFO vs average cost: which cost basis method should you use?

Here is a question that quietly decides how much profit your sells appear to make, and almost nobody bothers to ask it. When you bought the same share at two different prices and then sold half, which of those two purchases did you just sell? That choice is what “FIFO vs average cost” is really about, and your cost basis method is the thing that answers it. One method makes the realised gain on a trade look bigger. The other reports the very same trade as a smaller number. Nothing about the shares changed. Only the bookkeeping did. So let’s clear the fog.

What cost basis actually means

Cost basis is the boring fact sitting underneath every gain you will ever report. It is what a holding cost you, fees and all, because people forget the fees. When you sell, your profit is the sale proceeds minus that basis. A wrong basis gives you a wrong gain, every time, so it is worth getting right.

The catch is that you rarely buy a position in one clean lump. You buy a bit, then buy more later when it has moved, then maybe more again. Now you own a pile of shares that cost a jumble of different prices. Sell some of them and a fair question lands on the table: which ones did you sell? You cannot point at a specific share, because shares do not have name tags. So you need a rule. That rule is your cost basis method, and the two you will meet most often are FIFO and average cost.

How FIFO works

FIFO stands for first in, first out. The rule could not be simpler: the first shares you bought are treated as the first ones you sell. Your oldest tax lots go out the door first, and their original purchase price is the basis you subtract.

Picture it. You buy 10 shares at a tenner each, so 100 quid in. Months later you buy another 10 at 20 each, another 200 in. You now hold 20 shares. Then you sell 10 of them for 25 each, taking in 250. Under FIFO, the shares you just sold are the first 10, the ones that cost a tenner. Your basis on the sale is 100, your proceeds are 250, so your realised gain is 150. The 10 newer shares that cost 20 each are still sitting in your book, untouched, waiting for next time. These are illustrative numbers, not real prices, but the mechanic is exactly how it works.

The appeal of FIFO is that it is honest about time. Each lot keeps its own identity and its own purchase date, which matters because how long you held a thing often changes how it is taxed. Nothing gets blended into mush. You can always point at a sale and say precisely which purchase it drew down.

How average cost works

Average cost does what it says. Instead of tracking each lot separately, you blend every purchase into one pooled price per share, and every sale draws from that single average.

Run the same example. You bought 10 at 10 and 10 at 20, so you put in 300 quid for 20 shares. Average that out and every share now has a basis of 15, whichever day it actually arrived. Sell 10 at 25 and your basis is 150, your proceeds are 250, so your realised gain is 100. Notice what just happened. Identical purchases, identical sale, and the gain came out as 100 where FIFO gave you 150. The only thing that moved the number was the method.

Average cost is genuinely simpler to carry in your head, which is its whole pitch. One number, one pool, no fussing over which lot went where. The catch is that you have flattened away the individual purchase dates and prices, so you lose the fine control that comes from knowing exactly which lot you are selling. You buy convenience today and pay for it in precision when it matters.

Why the method changes your realised gain

Look at those two results again. FIFO said 150. Average cost said 100. Both are correct. They just answer slightly different questions. And here is the thing to walk away with. Your cost basis method is not some bit of back-office paperwork you can wave off. It feeds straight into the gain you report at year end.

It matters most in a rising market, where your older lots are your cheaper lots. FIFO sells the cheap stuff first, so it tends to surface a larger gain sooner. Average cost blends the cheap and the dear together, so the gain it reports lands somewhere in the middle. A bigger realised gain is not automatically worse. A gain you defer is usually a gain you meet later anyway. What the method really moves is the timing and the size of what shows up on your return, and that is the kind of thing you want to have decided on purpose, not stumbled into at year end.

One important caveat, said plainly. Which methods you are even allowed to use, and when, differs by jurisdiction, and some asset types carry their own rules. This is the general mechanic, not tax advice for your specific situation. Check the rules where you live, or ask someone who does this for a living.

What Strata does with your cost basis

Strata derives cost basis using FIFO tax lots by default. Every purchase you log becomes its own lot, with its own price and date, and when you log a sell the oldest lots are drawn down first. Realised profit and loss is worked out as you record those sells, and unrealised P&L on what you still hold updates from public market data. Because it all derives from the lots you entered, the basis stays reconcilable. You can hold the number up against your own statements and see exactly where it came from, which is the whole reason to keep a book you typed yourself rather than one a robot scraped.

Because this is a manual-entry workbench by design, the lots are yours, not a guess pulled out of a flaky connection. Fat-finger an entry and you void it. It gets flagged and dropped from every calculation, but it stays in the audit log instead of vanishing, the way an accountant strikes a line through a mistake rather than reaching for the eraser. That same lot tracking holds up when your book is spread across several brokerage accounts, so one method runs over the whole pile rather than a different convention per broker.

None of this turns you into a tax accountant. It just means you have learned the one thing most investors never bother to. Your cost basis method is a choice, and that choice moves your realised gain. A basis you can reconcile against your own statements is worth a lot more than one you have to take on faith. Pick the method deliberately and keep the lots clean, and the year-end maths stops being something you dread. If a book you can actually stand behind sounds like the standard your money deserves, you can build your portfolio and start logging lots today.