VA Investment Software
HOW VALUE AVERAGING ADDS VALUE
Achieving Investment Goals Even in Tough Economic Times
Written by
Bruce Ramsey
November 15, 2010
Copyright 2010 VA Investment Software, All rights reserved
How Value Averaging Adds Value
The purpose of this document is to demonstrate that by using the Value Averaging (VA)
investment strategy, the probability of achieving the target value for a portfolio is very high over a 5
or 10 year time frame. In addition, it will show that above average returns are possible without
increasing risk. It will also demonstrate that Dollar Cost Averaging (DCA) fails in most instances
of helping investors to achieve their savings target.
Value Averaging is a formula investment strategy which has be shown to achieve lower average costs
and higher rates of return than alternative strategies. The power of the Value Averaging method
derives from its marriage of two proven but separate techniques: Dollar Cost Averaging and
Portfolio Rebalancing. Value Averaging is not new as it was first researched and written about in
1988 by then Harvard Professor Dr. Michael Edleson. By considering a portfolio’s expected rate of
return (something that the "Dollar-Cost Averaging" method neglects), the "Value Averaging"
method helps to identify periods of over and underperformance. The mathematical imperative of
Dollar Cost Averaging, the time honored purchase of equal periodic amounts of stock or mutual
funds, forces investors to buy more shares when prices are low than when they are high, increasing
overall returns, on average. Rebalancing, on the other hand, is most often applied to mature
portfolios and mandates the periodic adjustment of portfolio allocations back to a set policy, forcing
a strong policy of “buy low / sell high” discipline into an investors trading decision making. The
genius of VA lies in the combination of the two techniques, VA and DCA, into the accumulation
phase of a portfolio. Not only are more shares bought when prices are low and fewer shares when
prices are high, as with DCA, but more money is deployed into stocks when prices are low and less
when prices are high, producing yet more salutary long term results.
Basically, the idea behind dollar-cost averaging is that instead of investing a lump sum of money all
at once, you invest it a little bit at a time over a specific period. So, for example, if at the beginning
of the year you had $12,000 that you wanted to invest in stocks, you might invest $1,000 each month
over the course of a year instead of investing it all at once. The idea is that you reduce risk because
you're buying stocks at a variety of prices throughout the year instead of buying all the shares at a
single price. Dollar cost averaging is a “Buy low, buy less high” strategy, as there are no rules for
selling.
Value Averaging works a bit differently. With Value Averaging, you first figure out how much
money you will need to accumulate for a goal such as retirement. Then, based on an annual rate of
return you expect to earn on your investments, you calculate how much you must invest each month
to achieve that goal. When a portfolio is underperforming, share prices are likely to be low. And
that’s when you’ll be investing more to make up for the under performance. When the portfolio is
outperforming your target rate return, share prices are likely to be high. That means it is not a good
time to buy and you could even sell for a profit, provided you maintain your pre-determined average
growth rate.
Value Averaging offers investors an alternative to investing a lump sum of money in times of market
uncertainty by allowing them to ease into the market over time, which reduces the timing risk. The
mechanical aspect of VA provides an investment discipline that requires no market forecasts and is
relatively simple to initiate.
At VA Investment Software we have developed a proprietary software program that allows us to
back-test the value averaging investment method, over any time frame, using historical data from
any North American Stock, ETF or US based mutual fund. The program also compares Value
Averaging against Dollar Cost Averaging.
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How Value Averaging Adds Value
Investment Scenario
Let us assume that if an investor was age 55 today and wanted to retire in the next 5 years and he
needed to accumulate and additional $100,000 in capital and assuming an 8% rate of return and 3%
for inflation, he would have to save $1,269 per month.
Here's where the "value" part of value averaging comes in. Based on the objective of the investor
above, at the end of the first year, instead of having the $16,020 he should have had to be on track
toward his $100,000 goal, the market leaves him with just $15,000. That would mean that the next
month, instead of investing the usual $1,269, he would invest $2,289 to bring the portfolio value to
where it’s should be to remain on track toward his goal. In fact, he would go through this process
each month. In months where the portfolio falls behind, he would add to the amount he invested
each month. And in months where the returns are higher than expected and the portfolio's value
gets beyond where it needs to be, he would scale back his monthly investment, or even possibly end
up selling some shares.
The examples on the following pages use actual historical data from the last 5 -10 years with the
following criteria:
Target value $100,000
Time period: 5 years ending October 31, 2010
Minimum monthly investment $1,269
Maximum investment: Capped at 3 times the monthly investment
Projected portfolio growth rate: 8%
Inflation rate 3%
Board lot trades only No
Selling rule: Immediate selling of shares on sell signals
Timing Monthly trades
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How Value Averaging Adds Value
Example 1
In our first example we will use a broad market ETF, the Vanguard Total Stock Market Index
(Symbol: VTI). We will start by initially investing $1,269 per month over 5 years as in our retirement
example explained in the previous paragraph.
Value Averaging Dollar Cost Averaging
Amount Total Year End Value Amount Total Year End Value
Invested Invested Invested Invested
End of Yr 1 $14,738 $16,020 $15,444 $16,729
End of Yr 2 $16,398 $31,136 $33,858 $15,914 $31,359 $34,053
End of Yr 3 $31,117 $62,253 $44,541 $16,398 $47,757 $32,828
End of Yr 4 $12,326 $74,579 $75,660 $16,897 $64,654 $61,969
End of Yr 5 $12,135 $86,714 $100,000 $17,411 $82,065 $89,679
Time frame: Oct 1 2005 to Oct. 31 2010
Value Averaging Portfolio Dollar Cost Averaging Portfolio
Adjusted Cost Base $86,714 $82,065
Current value $100,000 $89,679
Cash in portfolio $6,458 $0.00
Total Portfolio Value $106,458 $89,679
Total return 30.63% 19.64%
Annualized Return* 5.59% 3.71%
Average cost per share $53.49 $56.44
* Dollar weighted
From the above results:
• The Value Averaging strategy outperformed the Dollar Cost Averaging strategy and the
investor ended up with $6,458 (6.4%) more capital than the investors required savings target.
• The Value Averaging strategy outperformed Dollar Cost Averaging by $16,779 or 18.7%
• With Dollar Cost Averaging the investor failed to reach the $100,000 retirement target with a
shortfall of $10,321 or 10.3%
• For the 5yr period ending October 31 2010 the Vanguard Total Stock Market Index ETF
had an actual annualized return of 2.41%.
• The Value Averaging investment strategy outperformed the actual fund by 3.18%
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How Value Averaging Adds Value
You would be selling as
You would be building a
You would be making the fund started to rise
position as the fund was
rising gradually. larger purchases as the and building a small
fund price was falling cash position.
and the portfolio fell
below its target value.
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How Value Averaging Adds Value
Example 2
In our second example we will use a more aggressive ETF, the iShares S&P Global Technology
(Symbol: IXN). We will start by initially investing $1,269 per month as explained in the investment
scenario section.
Value Averaging Dollar Cost Averaging
Amount Total Year End Value Amount Total Year End Value
Invested Invested Invested Invested
End of Yr 1 $14,693 $16,020 $15,444 $16,714
End of Yr 2 $14,735 $29,428 $33,858 $15,915 $31,359 $35,708
End of Yr 3 $31,674 $61,102 $41,154 $16,398 $47,757 $30,452
End of Yr 4 $6,837 $67,939 $75,660 $16,897 $64,654 $66,862
End of Yr 5 $15,300 $83,238 $100,000 $17,411 $82,065 $93,081
Time frame: Oct 1 2005 to Oct. 31 2010
Value Averaging Portfolio Dollar Cost Averaging Portfolio
Adjusted Cost Base $83,238 $82,065
Current value $100,000 $93,081
Cash in portfolio $12,508 $0.00
Final Portfolio Value $112,508 $93,081
Total return* 48.17% 28.76%
Annualized Return* 8.32% 5.28%
Average cost per share $48.82 $51.71
* Dollar weighted
From the above results:
• The Value Averaging strategy outperformed the Dollar Cost Averaging strategy and the
investor ended up with $12,508 (12.5%) more capital than his required savings target.
• The Value Averaging strategy outperformed Dollar Cost Averaging by $19,427 or 20.8%
• With Dollar Cost Averaging the investor failed to reach the $100,000 retirement target with a
shortfall of $6,919 or 6.9%
• For the 5yr period ending October 31 2010 the iShares S&P Global Technology ETF had an
actual annualized return of 3.87%.
• The Value Averaging investment strategy outperformed the actual fund by 4.45%
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How Value Averaging Adds Value
You would be making You would be selling as
You would be building a larger purchases as the the fund started to rise
position as the fund was fund price was falling and building a cash
rising gradually and portfolio fell position.
below its target value.
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How Value Averaging Adds Value
3 – No Selling Rule
If you held your ETF in a taxable account, an investor could implement a “no sell” rule where the
system would not make any sell transactions that would trigger possible capital gain taxes. In
addition, since DCA has no rules for selling you could make VA perform similar to DCA except
that the amount of the periodic purchase would vary where in DCA purchases are fixed. Using
iShares MSCI Emerging Markets (Symbol: EEM) ETF.
Value Averaging Dollar Cost Averaging
Amount Total Year End Value Amount Total Year End Value
Invested Invested Invested Invested
End of Yr 1 $14,139 $16,020 $15,444 $17,268
End of Yr 2 $8639 $22,778 $33,858 $15,915 $31,359 $43,659
End of Yr 3 $35521 $58,299 $37,941 $16,398 $47,757 $29,413
End of Yr 4 $16728 $75,027 $97,802 $16,897 $64,654 $76,032
End of Yr 5 $0 $75,027 $112,966 $17,411 $82,065 $107,417
Time frame: Oct 1 2005 to Oct. 31 2010
Value Averaging Portfolio Dollar Cost Averaging Portfolio
Adjusted Cost Base $75,027 $82,065
Current value $112,966 $107,417
Cash in portfolio $0 $0.00
Final Portfolio Value $112,966 $107,417
Total return* 102.07% 69.53%
Annualized Return* 15.38% 11.33%
Average cost per share $30.82 $35.46
* Dollar weighted
From the above results:
• The Value Averaging strategy outperformed the Dollar Cost Averaging strategy and the
investor ended up with $12,966 (12.9%) more capital than his required savings target.
• The Value Averaging strategy outperformed Dollar Ccost Averaging by $5,549 or 5.16%
• For the 5yr period ending October 31 2010 the iShares MSCI Global Technology ETF had
an actual annualized return of 13.82%.
• The Value Averaging no-sell investment strategy outperformed the actual fund by 1.56%
• With both Value Averaging and Dollar Cost Averaging the investor reached the $100,000
retirement target, however VA still beat DCA by 4.05%. and DCA failed to beat the fund.
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How Value Averaging Adds Value
You would be building a You would be making There would be no
position as the fund was larger purchases as the selling as the fund price
rising gradually fund price was falling rises and no buying as
and the portfolio fell the fund is above its
below its target value. target value.
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How Value Averaging Adds Value
10 YEAR ANALYSIS
Using iShares S & P Small Cap 600 (Symbol: IJR) ETF, over a ten year time period the results are
just as consistent.
You would be making
You would be building a You would be selling as
larger purchases as the
position as the fund was the fund started to rise
fund price was falling
rising gradually and building a cash
and the portfolio fell
below its target value. position.
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How Value Averaging Adds Value
Value Averaging Portfolio Dollar Cost Averaging Portfolio
Adjusted Cost Base $77,579 $66,903
Current value $100,000 $91,435
Cash in portfolio $16,570 $0.00
Final Portfolio Value $116,570 $91,435
Total return 121.22% 86.49%
Annualized Return* 8.34% 6.49%
Average cost per share $49.12 $46.32
Time frame: Oct 1 2000 to Oct. 31 2010
* Dollar weighted
From the above results:
• The Value Averaging strategy outperformed the Dollar Cost Averaging strategy and the
investor ended up with $16,570 (16.5%) more capital than his required savings target.
• The Value Averaging strategy outperformed Dollar Cost Averaging by $25,135 or 27.4%
• With Dollar Cost Averaging the investor failed to reach the $100,000 retirement target with a
shortfall of $8,565 or 8.5%
• For the 10yr period ending October 31 2010 the iShares S&P Small Cap 600 ETF had an
actual annualized return of 6.42%.
• The Value Averaging investment strategy outperformed the actual fund by 1.92%
SUMMARY / CONCLUSIONS
Results strongly suggest, believe it or not, that value averaging does actually provide a performance
advantage over dollar-cost averaging, without incurring additional risk. While this paper only
illustrates four securities, we have tested the VA method with many different securities and the
results have consistently demonstrated that VA outperforms.
Value Averaging works better than DCA in almost all market conditions but the benefits are really
accentuated in a more volatile market. For a fund/stock with very little volatility, VA will still work
better but the benefits may not be as great. As might be expected from a technique that does
outperform, the higher the price variability and the longer the investment time horizon the better.
the result. Each gives value averaging the time and the opportunity to work its “magic”.
Given that the VA method invests a range of money from a minimum to a maximum every month,
it is likely that an investor could get under exposed in the market. For example, this could happen
when lesser amounts are invested in a sustained bull run in the market. In such a situation, VA will
still outperform DCA with respect to the rate of return, but the overall dollar gain might be lower.
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How Value Averaging Adds Value
The back-testing was done with a set (capped) maximum investment amount every month. The
results could differ if an investor chooses to invest without any such maximum (based purely on the
VA formula outcome). Investment returns can also be enhanced further by adjusting the parameters
of the analysis tool.
Irrespective of the stock market direction, if your investment is in a sound fund, VA will increase
your returns beyond simple DCA for the same time period. And it does so at a lower level of risk.
Regardless of what method you end up using, the key to better investing is discipline. If you have
discipline, you will be better off than the majority of the investors in the stock market.
Value Averaging is a simple but promising method of investment that savvy investors can chose to
adopt as part of a well-rounded financial plan. We believe that it is a strategy that works well
regardless of the economic times and it allows investors to feel comfortable knowing that there is a
high probability that their capital accumulation needs will be met. While past out-performance is no
guarantee of future out-performance, investors and financial advisors should consider implementing
the Value Averaging strategy since the probability of achieving the target value for a portfolio is very
high and hence ideal for financial / retirement planning. Stock brokerage firms would also benefit
from this technique enabling them to offer a research based "sell" as well as their plentiful "buy"
signals.
About VA Investment Software
VA Investment Software develops web-based applications for the financial services industry. Bruce
Ramsey, co-founder, has over 15 years experience in developing financial software ranging from
financial planning, stock and mutual fund databases and portfolio management systems.
Contact: Bruce Ramsey – Tel. 905-901-3063
email: sales@[Link]
For detailed analysis reports as well as a more theoretical review of the two strategies and examples
of how they compare under different market conditions, you can refer to the research section at
[Link]
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