Unrealized Gains and Losses (often called 'paper profits and losses') represent the change in value of an Asset you currently own but have not yet sold. Imagine you buy a stock for $100. A week later, its Market Value is $120. You have a $20 unrealized gain. It's a “gain” because your investment is worth more, but it's “unrealized” because that $20 isn't cash in your bank account. It only exists on your brokerage statement—on paper. Similarly, if the stock price drops to $80, you have a $20 unrealized loss. You haven't actually lost $20 until you hit the sell button. This concept is fundamental to investing, as it tracks the performance of your holdings before you decide to cash in or cut your losses. It's the difference between your asset's current market price and its original purchase price, or Cost Basis.
Let's say you, a savvy value investor, identify a wonderful coffee company, 'CoffeeCo'. You buy 10 shares at $50 per share.
A few months later, CoffeeCo reports stellar earnings, and the stock price jumps to $70 per share.
This $200 is your paper profit. It feels great, but it's not yours to spend yet. If a market panic drives the price down to $40, the situation reverses:
Watching your portfolio's value swing with unrealized gains and losses is an emotional rollercoaster. A large unrealized gain can lead to greed and a temptation to sell too early. A scary unrealized loss can provoke fear, leading to panic selling at the worst possible time. This is where the wisdom of Benjamin Graham's allegory of Mr. Market comes in. Mr. Market is a manic-depressive business partner who offers you wildly different prices for your assets every day. A value investor's job is to ignore his mood swings. The focus should remain on the company's long-term Intrinsic Value, not the temporary paper figures. An unrealized loss on a great company is often just Mr. Market being pessimistic, offering you a chance to buy more at a discount.
This is one of the most powerful, yet often overlooked, aspects of unrealized gains. You do not owe any Capital Gains Tax on your profits as long as they remain unrealized. The tax clock only starts ticking when you sell the asset and lock in the profit, converting it into a Realized Gain. This deferral is a massive advantage for long-term investors.
Furthermore, in many jurisdictions like the US, the tax rate itself depends on how long you held the asset. Gains on assets held for more than a year are typically taxed at a lower Long-Term Capital Gains rate, while those held for a year or less are hit with the higher Short-Term Capital Gains rate, which is often the same as your income tax rate. This tax structure heavily incentivizes patient, long-term investing.
For a value investor, unrealized gains and losses are simply score-keeping, not a call to action. The legendary Warren Buffett has famously said he is happy when the stocks of his favorite companies go down, as it allows him to buy more at a bargain price. An unrealized loss in a fundamentally sound business is an opportunity, not a failure. An unrealized gain is a pleasant confirmation that your analysis was sound, but it's the underlying business performance—its earnings, Competitive Moat, and management—that truly matters. Your goal isn't to chase paper profits but to own pieces of excellent businesses. Let those gains remain “unrealized” for as long as possible, allowing the magic of Compounding to work its wonders, untaxed, for years or even decades.