By Dr. Jim Dahle, WCI Founder
I've been getting emails from WCIers (and my own daughter) that Vanguard is sending them emails with this message. The email starts with the title: “Action needed: Choose an automated cost basis method.”
And from there, Vanguard describes its recent decision to stop using the SpecID option as an automated cost basis method in your taxable account. Instead, beginning in August 2025, it says the only automated methods will include: FIFO, MinTax, and HIFO.
Here's the entire email.
The emailers ask, “Which one should I pick?”
So far, I've just been reassuring them that it doesn't matter. As Vanguard says, “You'll still be able to use SpecID for individual transactions.” I intend to take Vanguard up on that offer, as I always have when selling shares to tax-loss harvest or donating shares to our Donor Advised Fund (DAF). But since you have to pick something and since FIFO is probably the worst thing to pick, I tell them to pick “MinTax,” which should be slightly better than HIFO.
I wasn't sure why I had not yet received this email. Perhaps it was because we have a pretty large account, so maybe we're exempt from the requirement. Perhaps it's because our taxable account is in a trust, and maybe it's exempt. Maybe Vanguard just hasn't gotten around to sending me an email, or I just missed it somehow. I logged into my Vanguard account on July 23, 2025, to check things out. There were no messages to me or any pop-up notices. So, I went to the cost/basis page, and this is what I saw.
Sure enough, my cost basis settings are still all on Specific Identification (SpecID) (well, except for DISV, a relatively recent purchase since it is our tax-loss harvesting partner for AVDV).
I figured while I was in there, I would just change my method. Sure enough, SpecID was still available, and that's what I chose.
While I have no idea why some Vanguard investors are getting this message and I'm not, this is a good opportunity to discuss the various cost basis methods and what they mean. But first, let's define some terms.
What Is Cost Basis?
Cost basis is simply what you paid for a security, like a mutual fund. If you bought it for $10 a share and later sell it for $12 a share, your cost basis is $10. You'll only owe capital gains taxes on $2 per share. Think of it as your principal.
More information here:
What Is a Tax Lot?
A tax lot is simply a single purchase of shares bought in a non-qualified (taxable) brokerage account at a specific time. If you buy shares every month, you'll have a tax lot for every month. If you log into your brokerage account and look at your cost basis (at Vanguard, click on “Holdings,” use the menu to scroll down to “Cost basis-Unrealized gains/losses” and then scroll down to the applicable account), it'll look something like this:
In this example, you can see some larger tax lots, like the one on Oct. 9, 2018, and you can see periodic smaller ones, such as the one on December 21, 2018. This is what happens if you're reinvesting dividends in a taxable account. You just end up with a whole bunch more tax lots. It's not the end of the world since the brokerage will keep track of them all, but it does add some complexity. This is one reason why we don't reinvest dividends in our own taxable account (the account above is a UTMA for one of my kids). The other reason is to decrease wash sale issues when tax-loss harvesting. So, we have a lot fewer tax lots for our holdings than our kids do, despite having a much larger account. In fact, we only have four tax lots of VXUS (and six of IXUS, its tax-loss harvesting partner), something we've been investing in regularly for many years. By avoiding the automated reinvestment of dividends, consolidating tax lots when tax-loss harvesting, and donating shares to charity, you can actually keep the number of tax lots pretty low, even with large accounts.
What Is a Cost Basis Method?
The cost basis method is simply how the brokerage, such as Vanguard, decides which shares to sell when you go to sell shares. For example, if you have chosen First In, First Out; you don't manually select which tax lot to sell; and you go to sell 100 shares, the brokerage will simply sell the oldest 100 shares of that security in the account. That may result in less-than-ideal tax consequences, especially if you're trying to tax-loss harvest the most recent shares you purchased.
What Are the Cost Basis Methods?
Vanguard apparently currently offers (me) four of their five cost basis methods from which to choose. Four of those five are pretty standard and available anywhere. One of them is relatively new, and other brokerages have similar new options.
First In, First Out
First In, First Out (FIFO) is often the default method, although I'm not sure why since it seems that's the worst possible method. In general, the shares in the first tax lot you ever bought were probably the cheapest. They have the lowest basis and thus the highest tax bill associated with their sale. But that's how FIFO works; the brokerage just sells the first shares you bought.
Last In, First Out
Last In, First Out (LIFO) seems a little bit better. In this method, the brokerage sells the most recent shares purchased until it gets to the number of shares you have ordered to sell. The basis on these should be a lot higher, and the tax bill should be lower. However, there's a catch. These are not always the highest basis shares since share value fluctuates. Plus, there's a lot better chance that the most recent shares purchased were bought within the last year, and selling those at a gain would result in a short-term capital gain (taxed at ordinary income tax rates) instead of a long-term capital gain eligible for the lower long-term capital gains tax rates.
Average Cost
Average Cost (AvgCost) might be easy, but it's also a less-than-ideal method for those of us who actually want to minimize our tax burdens. It basically just averages your cost basis for all of your shares ever purchased. The worst part about this method is that once you sell some shares for a holding using AvgCost, you're locked into that method until all the shares are sold. Maybe there is a situation where this is a good thing, but I can't think of one. It could even turn long-term gains into short-term gains. This method is so bad that Vanguard makes you opt into it in writing rather than online.
Specific Identification
Specific Identification (SpecID) solves all these issues by letting you manually select which tax lots to sell. It's definitely the way you want to deal with the sales of any shares if you care about controlling your tax bill. This allows you to tax-loss harvest only shares with losses. It allows you to make sure anything sold with a gain has a long-term capital gain. It allows you to donate to charity the lowest basis shares owned for at least a year. If you're in the 0% capital gains bracket and want to take advantage of that, it allows you to select the lowest basis shares so you can tax-gain harvest. When raiding my oldest daughter's UTMA lately, I've been picking the low basis shares, as she doesn't have enough income to owe any long-term capital gains taxes on those sales. Incidentally, I no longer have access to her UTMA since her 21st birthday, so I'm teaching her how to deal with this issue. Now, she can legally get drunk and increase her own tax bill.
Minimum Tax
The Minimum Tax (MinTax) method is the newest addition to the list. Since SpecID works so well, I didn't bother learning exactly how it works until recently. I think it's for people who don't really understand cost basis and capital gains tax or who just can't be bothered with details like that. For this post, I dove into how it actually works. Thankfully, Vanguard provides a definition of each method along with pros and cons. Here's what it says about MinTax:
Specifically, Vanguard says it sells shares in this order:
- Short-term capital loss from largest to smallest.
- Long-term capital loss from largest to smallest.
- Short-term zero gain or loss.
- Long-term zero gain or loss.
- Long-term capital gain from smallest to largest.
- Short-term capital gain from the smallest to largest.
Basically, it assumes you are not in the 0% LTCG bracket and sells the shares that will result in the lowest tax bill for this transaction. Most of the time, that's first going to be any shares with a loss, followed by the highest basis shares with a gain that you have owned for at least a year. That's a long list of cons above, though, so I'm going to keep using SpecID and manually select which shares are sold—even if, at some point, I can no longer choose it as my “default” cost basis method. SpecID allows me to consolidate tax lots by selling/giving tiny lots and minimizing my overall lifetime tax bill. But as a default method, yes, MinTax is pretty darn good.
More information here:
Vanguard vs. Fidelity — Which Is Best for Your Investments?
Will I Be Protected If My Investment Broker Goes Bankrupt?
Fidelity
Other brokerages also offer cost basis methods designed to reduce your tax burden. If you go to Fidelity, you'll see even more options, including:
- First In, First Out
- Intraday First In, First Out
- Last In, First Out
- High Cost
- High Cost, Long Term
- High Cost, Short Term
- Low Cost
- Low Cost, Long Term
- Low Cost, Short Term
- Tax Sensitive
- Tax Sensitive, Short Term
Look at all the stuff you don't have to learn if you're willing to just specifically identify the tax lots from which you wish to sell shares! Here are Fidelity's descriptions:
Schwab
Schwab doesn't offer as many options as Fidelity, but it still has the following
- First In, First Out
- Last In, First Out
- Average Cost
- Low Cost
- High Cost
- Tax Lot Optimizer
- Specific Identification
Tax Lot Optimizer seems to be about the same as MinTax at Vanguard and Tax Sensitive at Fidelity. The Schwab description reads:
“The Tax Lot Optimizer uses an algorithm to calculate the optimal way to minimize the tax impact of each sale. In general, the goal is to sell investments for losses first (short-term losses, then long-term losses) and gains last (long-term gains, then short-term gains). Like the high-cost lot method, the Tax Lot Optimizer looks for the highest cost shares first, and the algorithm also considers the holding period of each share. This method can be a good option for investors seeking to minimize taxes or looking to tax-loss harvest. But be aware, although this method tries to avoid short-term capital gains, that's not always possible if shares have been held less than one year.
In case you're not sure what you're probably supposed to do when you're using SpecID, that should give you a pretty good idea. Sell shares with high basis owned for at least a year, and give shares with low basis owned for at least a year.
The Bottom Line
When selling or giving shares from your taxable account, specifically identify those shares. If Vanguard is forcing you to choose a “default cost basis method,” choose MinTax.
What do you think? Did you get the letter? What did you choose? Do you do anything other than SpecID when selling or giving shares?
SpecID is no longer an option (Aug 2) and mine were moved to FIFO (which I changed), but hopefully this is just the selection for automated sales, and manual sales can still use the specific lot.
I don’t think there is any “hopefully” about it. It’s very clear that is all this election applies to.
How do you make sure you make a manual and not an automatic sale?
I think you have to set up automatic sales beforehand. I dunno, never done one. When I want to sell something (usually to TLH) I just go in and do it. I assume people can set it up, perhaps in retirement, so they get $4,000 transferred to their bank account every month or something with automatic sales.
Ahh, gotcha. Thanks
As I logged in this am, all of my accounts had been reset to FIFO, so I changed them all to MinTax. Never did get the email although my rep did leave me a voicemail asking me to make an appointment with him for “some housekeeping stuff.”
I read the email and immediately just deleted it as no action necessary as there is little chance one selection is better than another every time. Truthfully, I am going to want to control my taxes, by using Spec ID. MinTax will not do that for you.
As to why you didn’t receive it — we got a snail mail letter! — our account is also a trust, and well into 7 figures. As a very long-term Vanguard account holder, all I can say is that IMHO Vanguard’s systems are still an unholy stinking mess.
In this day and age, and I must confess that I did spend 20+ years in the industry, I can’t believe that it takes Vanguard 2 business days to process a dividend from one of their fixed income funds and reinvest in one of their money market funds.
Sorry for the off-topic rant, but forcing us, the customers, to abandon SpecID as our default is just plain silly, and mildly infuriating.
Anyway, thanks for the detailed write-up — good info for me to pass on to others in the family who didn’t do portfolio accounting and still use me to manage their investments and do their taxes.
I received a snail mail letter instead of an email as well.
I agree that forcing people away from Specific ID as an automatic cost basis is stupid, and at first I was worried about what I was going to do instead. But then I realized that I have no accounts with Vanguard that will have any automatic withdrawals occurring, so it really doesn’t matter much. The only stock transactions I have done of any significance have been transferring shares to my DAF with Schwab. Accordingly I may stick with FIFO, as that will gradually flush out my oldest purchases that occurred prior to 2011, where the only cost basis Vanguard has recorded for those shares is Average Cost
Good article, interesting that you point out that highest basis for longest term held is likely the best (more than a year) to basically keep a cushion on the oldest shares that maybe you’ll eventually die with but always populate the account to make sure you have something?
Does anyone here have experience with the Schwab Tax Lot Optimizer?
Thanks JD
It’s not about a cushion, those are just the shares with the lowest tax bill associated with selling them. Shares with a loss. Shares with no gain. Shares with small long term gain.
No taxable account at Schwab, sorry.
If you are donating shares of stock to your Donor Advisor Fund, wouldn’t you likely want to choose FIFO? It seems to me that you would want to donate shares that have appreciated the most (usually those which have been held longest). Am I thinkimg correctly?
No, I want to pick the exact shares I want to donate, but there’s a good chance I’d pick the same ones that an automatic FIFO would. You’re right about that. But I’m a control freak.
Thanks so much for writing this. WCI continues to educate and inform!
It says you can still chose SpecID at purchase I believe…but I tried to buy mutual funds today and that was not an option at purchase. Has anyone figured this out. As has been mentioned…I want the control to pick which shares are most advantageous to me
Huh? I think spec ID only matters when you sell your shares…. You purchase based on market price or you set a limit price. Etc. … maybe I’m misunderstanding
It doesn’t matter when you buy. It matters when you sell.
This article is missing an option from Vanguard (probably because you didn’t see change yet), and thus does a bit of disservice to more savvy readers. The change was made in August, so if not exempt because in trust you will probably see it now.
The missing cost basis from the article above is “highest in, first out”. For anyone who has done capital gains harvesting, this is going to be better than the min tax option (up until you’ve used them all up), since it will prioritize small short term gains over large long term ones, while the min tax option does not. Hope you can update to include this, since I suspect more people are going to be surprised next time they go to Vanguard and get popup notifying them of the cost basis method change, and come here looking 🙂
… and of course I meant capital loss harvesting 🤦♀️
Thanks for the update. Articles sure can get out of date fast eh? This thing was only written like 2 weeks ago, which is an incredibly short time period between writing and publishing for us.
In case you missed it, I don’t think ANYONE should really use ANY of the methods Vanguard is offering. They should just manually select which tax lots to sell, essentially still using SpecID.
At any rate, I suspect MinTax and HIFO choose the same lots most of the time, no?