If you’ve ever sold an investment at Vanguard, you’ve likely been stopped by a screen asking you to “choose a cost basis method”.
Most people pause, skim the options, pick something that sounds reasonable or just click “continue,” and move on without realizing that this small decision can affect their taxes.
This guide explains what Vanguard is asking and why. I’ll cover what each option means and what to think about when choosing one.
(While this article uses Vanguard as the example, the underlying cost basis decision applies at every major brokerage. The main difference is what the options are and where that decision is made.) (See How to Choose a Cost Basis Method When Selling Investments at Fidelity or Schwab)
What does “cost basis” mean?
Your cost basis is simply what you paid for an investment.
When you sell that investment, the IRS calculates:
sale price – cost basis = capital gain or loss
This applies to taxable brokerage accounts. Cost basis methods generally do not apply to sales inside tax-advantaged accounts like IRAs.
It sounds simple, but what complicates it is that most people didn’t buy all their shares at once. You may have invested monthly, reinvested dividends, or added money over time. Each of those purchases has a different cost basis.
Choosing the cost basis method when selling tells Vanguard which shares to sell first.
Why Vanguard asks you to choose
Brokerages are required to track and report cost basis information to the IRS. But you get to decide which shares are sold. This is important because that choice affects:
- How much tax you owe
- Whether gains are short-term or long-term
- How much flexibility you have in the future
Once a choice is selected, this becomes the default method for that investment unless you intentionally change.
If you don’t actively pick a cost basis method, Vanguard will apply the account’s default method. For most stocks and ETFs, that default is typically First In, First Out (FIFO) and for most mutual funds the default is typically Average Cost.
Vanguard cost basis options explained simply
Minimum Tax (MinTax)
What it does:
Vanguard’s program automatically selects shares with the goal of minimizing taxes for each sale
This often means:
- Favoring long-term gains over short-term
- Selling shares with smaller gains
- Using losses when available
Why someone might choose it:
- You want a hands-off approach
- You’re not actively planning around taxes
- You’re comfortable with automation
Things to watch:
- You’re delegating the decision to an algorithm, and effectiveness will vary
- It only considers the current transaction, not broader planning goals
- Other brokerages offer similar tools, but they may rely on different assumptions or defaults
Specific Identification (SpecID)
What it does:
- You choose exactly which shares to sell
Why someone might choose it:
- You want flexibility and control
- You want tax benefits for your specific situation
- You want to manage gains or losses intentionally
- This is often considered the most planning-friendly option
Things to watch:
- Requires attention at the time of sale
- You must select the lots/shares each time
Highest In, First Out (HIFO)
What it does:
- Sells the shares with the highest purchase price first
Why someone might choose it:
- You want to reduce gains on a specific sale
- You understand the short-term gain risk
Things to watch:
- Ignores holding period (how long you’ve held the shares)
- Can trigger short-term capital gains unintentionally, which may lead to a higher tax bill
First In, First Out (FIFO)
What it does:
- Sells the oldest shares first
Why someone might choose it:
- Simple and predictable
- Often results in long-term gains
Things to watch:
- Frequently creates larger taxable gains
- Very little flexibility
Average Cost (Avg Cost)
What it does:
- All shares are averaged together and treated as if they have the same cost
Why someone might choose it:
- You value a simple, set-it-and-forget-it approach
- You invest primarily in mutual funds
Things to watch:
- You lose lot-level control
- Ability to switch methods later can be limited
The choice is not permanent, but timing matters.
- You can usually change the default method before you sell
- You can often override the default for a specific transaction
- Once a sale is completed, the cost basis method used for those shares is final and will be used for tax reporting
This screen appears quickly but it is an important one.
Before You Click “Continue” on Vanguard’s Cost Basis Screen
Pause and use this quick checklist to avoid making an accidental decision.
- Am I selling all of my shares, or just a portion of this investment?
- Selling everything means the cost basis method usually won’t change the total tax.
- Selling part of a holding means the method does matter.
- Were my shares purchased at different times or prices?
- If yes, your choice determines which shares are sold and how much tax is triggered.
- Do I want simplicity or control?
- Want it simple? Choose FIFO, Average Cost, or MinTax.
- Want control? Choose Specific Identification.
- Are any of the shares short-term or long-term?
- Shares held one year or less are generally taxed at higher rates than long-term holdings, which is why holding period matters when choosing a method.
- Could this sale affect my taxes this year?
- Consider purchase timing, cost, other income, and whether gains would be short-term or long-term.
- Am I comfortable letting Vanguard decide for me?
- MinTax can be appropriate as long as you understand its assumptions and limitations.
- Do I understand how common methods behave in rising markets?
- For example, FIFO often sells the oldest (and lowest-cost) shares first, which can increase reported gains though outcomes vary.
- Am I trying to minimize taxes now, or intentionally realize gains for a specific reason?
- Different methods can lead to very different outcomes depending on your goal.
- Do I understand this choice becomes the default for future sales of this investment?
- You can usually change it for later sales, but not after a sale is completed.
The Takeaway
That Vanguard popup isn’t just a formality, it’s a tax decision.
You don’t need to optimize every dollar, but understanding what you’re being asked helps you:
- Avoid surprises
- Make more intentional choices
- Know when it’s worth slowing down or asking for help
Understanding what Vanguard is asking, and why, helps you make a deliberate choice instead of an accidental one.
Resources
- Vanguard: Cost basis methods available at Vanguard
- Vanguard: Cost basis: What it is and why it matters