What Is Paper Profit?
Paper profit is a term that is used in reference to a situation that might occur as part of investing when there is an upward review of an asset, which may be the consequence of an appreciation of the market value of the asset in question. When people make investments, something that may be in the form of a stock or some other defined type of asset, it is for an ascertainable sum of money. Even when people inherit the asset or security, it usually has a market value at the time that they inherit it. Over time, changes may occur in the market that may lead to a situation where the value of the assets will either increase or decrease, leading to a difference between the value of the item under consideration at the time and the value of the same item at the time the owner either purchased or inherited it. It is this upward appreciation of the value of the item that is known as paper profit due to the fact that the profit is only on paper and has not been converted to physical cash by the owner.
The owner of the asset may decide to convert it to a real profit only when such a person succeeds in selling the item for close to the increased price. In such a case, the profit will be whatever remains after the original market value has been subtracted from the total sale price, including taxes and other fees. An illustration of this can be seen in a situation where an investor purchases some stock in a computer company for a stated sum. If after two years the market value of the stock increases suddenly and the investor's stock experiences an upward increase of 40 percent, the 40 percent increase in the stock value will be the paper profit. This paper profit will be converted to real profit when the stock owner sells the stock and realizes at least 30 to 35 percent after the subtraction of fees and taxes.
Even though the concept seems positive, some investors have found it to be an impediment in their quest to maximize their profit from investments. For example, assuming the reason why the computer firm’s stock rose that high was due to a new product that generated a lot of interest, some investors might decide to convert the paper profit to real profit by selling the share, while others might not, thinking that the value of the stock will continue to rise. Assuming this does not happen, then the investors would have lost a valuable opportunity to make a healthy profit.
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