Value Averaging: An Automated Investment Strategy

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Don’t time the markets because you’re probably not smart enough to time the markets.

Sorry.  I guess I’m being a tad judgmental.  Let me simply say, I’m not smart enough to time the markets.  Neither are about a million other super intelligent people (unfortunately, most didn’t know it until it was too late).

Since your emotions are the greatest enemy of successful investing, you need a system and a structure in place to help you navigate the emotional waves of investing.

Many people use a simple and effective strategy called dollar cost averaging.  This is a great way to start investing.  However, today I want to introduce you to another simple, yet effective, investing strategy called – value averaging.  Remember, a winning combination is choosing the best investments and the best investing strategy.

As for the strategy, value averaging has been shown to consistently provide better returns than dollar cost averaging.

What is Value Averaging?

Value Averaging is an investing strategy where the amount you invest is determined by the current condition of the market.  This might sound like market timing, but instead it is a disciplined investment strategy that helps you purchase more shares when shares are lower.

When the market is strong, you will not put as much money into the market.  When the market is weak, you put more money into the market.

Value Averaging is based on the investment research done by Michael Edleson.

How To Start A Value Averaging Investment Strategy

When you start value averaging, you will need to answer two important questions:

  1. What is your total savings goal?  In other words, how much money do you want to have saved and by what date?
  2. What rate of return can you reasonably expect? This illusive number should probably be between 8-10%.

Implement a Value Averaging Investment Strategy by Creating an Investing Path or Road Map

Now that you have your investing timeframe and dollar amount, you simply do reverse calculations to determine how much money you should save each year.  These yearly amounts make up your investing path.  This will be your personal investing plan.

An Example:  Joe and Jill Investor

Joe and Jill investor want $30,000 in ten years.  Joe and Jill expect an average return of 8%.  Assuming an 8% rate of return they would need to invest $2,000 each year for the next 10 years.

Their investing road map would look like the following:

Year 1 $ 2,160.00
2 $ 4,492.80
3 $ 7,012.22
4 $ 9,733.20
5 $ 12,671.86
6 $ 15,845.61
7 $ 19,273.26
8 $ 22,975.12
9 $ 26,973.12
10 $ 31,290.97

To simplify this example, let’s assume that Joe and Jill track their investing progress at the end of each year.

Joe and Jill At Year One

Let’s say at the end of year one the markets were really strong and their investments were up 15%

This means they would end the first year with $2,300 (($2000*.15)+$2000)).  Since, according to their ‘investing path’, they need a $2160 balance at the end of the first year, they should invest $1860 into the market and $140 into a high interest saving account.

Summary at the start of year two:

Invested:  $4,160.00  / High interest saving account $140.00

If Joe and Jill get an 8% rate of return, they will be on track.  If it is less, they will fall behind their investing path.

Year two was a slow year and the markets only gained 6%.  Their investment ($2,300+$1,860 @ 6%) is now worth $4,409.60.  The total at the end of year two should be $4492.80.  They are officially behind their ‘investing path’.  Now they will need to add the full $2,000 contribution plus and extra $83.20 to help them get back on their ‘investing path’.

Summary at the start of year three:

Invested: $6409.60 / High interest checking account $56.80

On and on the cycle would go adding extra or adding less investment dollars into the market to help you keep on track to be sure you will reach your financial goal.

How often should you check your investing progress?

You can made this determination based on your own preferences.  It certainly does not need to be done more than once a month, but waiting more than once a year would be too long.  Some people prefer quarterly.  The more frequently it is done, the better.

Value Averaging Investment Strategy Vs. Dollar Cost Averaging Investment Strategy

Advantages of Value Averaging

Value Averaging offers better returns than dollar cost averaging

With dollar cost averaging, you are always investing the same number of dollars each and every month (statement updated 5/3/10).  Value averaging forces you to buy less shares when the market is higher and more when it is lower.  Thus, it is an investment strategy that puts a structure to the old advice – buy low, sell high.

I won’t rehash all the dry numbers, but if you are interested in the numbers, statistical evidence, or more information, you can download the following (free) pdf by Paul Marshall – A STATISTICAL COMPARISON OF VALUE AVERAGING VS. DOLLAR COST AVERAGING AND RANDOM INVESTMENT TECHNIQUES.

Disadvantages of Value Averaging

  1. More work is involved.

    While you can automate your payments with a dollar cost averaging plan, you cannot with value averaging.  Each month, quarter, or year, you will need to check your progress in comparison to the investing path.  You will then need to make the necessary adjustments.

  2. Your investments might fall too far behind your investing plan.

    If you started value averaging at the start of 2008, by the end of the year rather than being up 8%, you would be down 35%.  You might not have the money necessary to buy enough shares to get your investments back to the anticipated amount determined by the investing plan.  If, however, you could have made up the difference, your value averaging would have paid off nicely.

  3. The amount needed might be too hard to estimate.

    Let’s say you are a young person saving for retirement 40 years down the road.  There are so many retirement variables that it would be almost impossible to have an accurate value averaging plan.  However, the closer you are to your deadline, the more feasible your estimates become.

  4. It is difficult to guess the right expected return.

    Will you get 6%, 8%, 10%, 12%?  If possible, the lower you estimate, the more likely you are to reach your intended goal.

While value averaging does have some disadvantages to dollar cost averaging, it should in the long term outperform a dollar cost averaging investing strategy.  It is a viable option for those who are disciplined and willing to do a little extra work.

For those that do not have time to setup strategies yourself, there are companies tha such as Betterment.

Do any of you use a value averaging investment strategy?  Is it worth the extra time involvement?  Does it sound like a good strategy to you?


  1. BibleDebt says

    Sounds like a great idea, but it still seems to me like you are timing the market. You may think you are getting a value and then the market could go down. On the inverse, you may think the value is low and the stock price could rise. Keep investing and staying out of debt, at least you will have something when you need it.

  2. says

    Very informative Craig. I’ve never heard of value averaging. Since I don’t automate my Roth IRA contributions, this may be a strategy to look into more.

    However, like you mentioned, the hard part is determining the expected rate of return. In that sense, it does seem like you’re timing the market or gambling a bit. What if you run the numbers expecting 8 percent, but only get 6?

    And your point about a year with large negative returns is another potential drawback to this method. But if you can make up the difference with extra money, this strategy may be worth considering.
    .-= Darren´s last blog ..A Few Firsts For MORE than Finances! =-.

    • says

      If you are not automating your contributions is would be a good approach.
      I guess as for as the percentage if you chose a smaller number (like 6%) you could be sure you would make your goal. However, I still think that historically 8% would still be conservative.
      If you could make up the difference with extra money that would be AMAZING.
      As always, thanks for your comment.

  3. Anthony says

    I have to disagree with this statement: “With dollar cost averaging, you are always buying the same number of shares each and every month.”

    This is simply not true. Suppose I invest $100/month regularly (via the DCA method). In Month 1, I could buy stocks/bonds/CD’s/index funds/whatever-other-type-of-investment at $1.00 a share for 100 shares. In Month 2, I am still investing $100/month. But in Month 2, the stock is now $2.00 a share. You can then only buy 50 shares.

    Clearly then, you’re NOT buying the same number of shares each and every month. That is the point of DCA.

    I will agree that value averaging (VA) goes past DCA in buying even lower when the market is down. Unfortunately, *I* personally feel that it’s market timing…

    But the biggest disadvantage, as you mentioned in your article, is the level of involvement required. I’m investing in my 401(k). I’d rather leave it at a set percentage in order to reach the IRS limit each year. If I do VA, I’d change my contribution percentage on a regular basis and would never know if I’m on “track” to reach the limit.

    • says

      You’re right about buying the same number of shares – that was a misprint. It should say that you are investing the same number of dollars.
      No doubt there is more work involved.
      Thanks for the comment.

    • says

      In your case it doesn’t seem like value averaging will work. Value averaging is for people with a savings goal and money to continue investing on a regular basis. In your case you might invest it all at once or spaced out over a few months depending on the amount.

  4. Minda says

    Sounds like a good way to save for a predictable expense like college or a down payment for a house. Retirement would be harder because it’s hard to figure out what you’ll need and you have to work with contribution limits and other rules.

  5. Alogon says

    I wish I had known about value averaging years ago when I was saving for retirement. Craig is right, it’s best to think about it in connection with a regular influx of savings rather than a lump sum– although a lump sum is a good way to make a sizeable enough initial investment in a position that its performance can inform your value-averaging deployments subsequently. Otherwise the situation will resemble dollar cost averaging for awhile. I would recommend, after choosing a stock fund to invest via value averaging, that you consider its standard deviation (a measure of volatility). The greater its volatility, the more beneficial value averaging will be, but the amount you will need per period can vary greatly. Plan a path (as it is called) that will require no more than about half the total amount that you have to invest each period on average, and devote what is left over into a bond fund and/or “stable value fund” with good liquidity. If you are not overambitious, only rarely will your monthly or quarterly savings be inadequate to cover the plan– and in these rare cases, you have the other funds from which to make up the shortfall (i.e. rebalancing).

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