An increase or decrease in the value of an asset that an individual or entity still owns is termed either a potential profit or potential loss. This fluctuation in value is not realized for tax purposes until the asset is sold. For example, if an investor purchases a stock for $10 per share and its market price rises to $15 per share, the investor holds a paper profit of $5 per share. Conversely, if the market price drops to $8 per share, a paper loss of $2 per share exists.
Understanding the concept is crucial for accurate financial planning and investment strategy. It provides a more comprehensive view of an entity’s true financial position than simply considering realized gains and losses. Recognizing such fluctuations allows for more informed decisions about when to hold or sell assets, potentially impacting overall portfolio performance. Its consideration helps investors avoid knee-jerk reactions to market volatility.
