Value Averaging

DEFINITION of 'Value Averaging'

An investing strategy that works like dollar cost averaging (DCA) in terms of steady monthly contributions, but differs in its approach to the amount of each monthly contribution. In value averaging, the investor sets a target growth rate or amount on his or her asset base or portfolio each month, and then adjusts the next month's contribution according to the relative gain or shortfall made on the original asset base.

BREAKING DOWN 'Value Averaging'

For example, suppose that an account has a value of $2,000 and the goal is for the portfolio to increase by $200 every month. If, in a month's time, the assets have grown to $2,024, the investor will fund the account with $176 ($200 - $24) worth of assets. In the following month, the goal would be to have account holdings of $2,400. This pattern continues to be repeated in the following month.

The main goal of value averaging is to acquire more shares when prices are falling and fewer shares when prices are rising. This happens in dollar cost averaging as well, but the effect is less pronounced. Several independent studies have shown that over multiyear periods, value averaging can produce slightly superior returns to dollar-cost averaging, although both will closely resemble market returns over the same period.

The biggest potential pitfall with value averaging is that as an investor's asset base grows, the ability to fund shortfalls can become too large to keep up with. This is especially noteworthy in retirement plans, where an investor might not even have the potential to fund a shortfall given limits on annual contributions. One way around this problem is to allocate a portion of assets to a fixed-income fund or funds, then rotate money in and out of equity holdings as dictated by the monthly targeted return. This way, instead of allocating cash in the form of new funding, cash can be raised in the fixed income portion and allocated in higher amounts to equity holdings as needed.

RELATED TERMS
  1. Automatic Investment Plan - AIP

    An investment program that allows investors to contribute small ...
  2. Dollar-Cost Averaging - DCA

    The technique of buying a fixed dollar amount of a particular ...
  3. 401(k) Plan

    A qualified plan established by employers to which eligible employees ...
  4. Scale Out

    The process of selling portions of total held shares while the ...
  5. Average Down

    The process of buying additional shares in a company at lower ...
  6. Scale In

    The process of purchasing shares as the price decreases. To scale ...
Related Articles
  1. Retirement

    Rolling Over Your 401(k) in Times Of Volatility

    Learn the risks that come with rolling over a 401(k) in times of market volatility, and discover strategies that you can use to cope with these risks.
  2. Economics

    10 Ways to Protect Your Investments From an Interest Rate Hike

    Learn investment considerations and wealth-management options that aim to safeguard investor goals while interest rates rise in capital markets.
  3. Investing Basics

    Choosing Between Dollar-Cost And Value Averaging

    These are two investing practices that seek to counter our natural inclination toward market timing by canceling out some of the risk.
  4. Retirement

    Dollar-Cost Averaging Pays

    Get the most out of your mutual fund by using this simple but powerful strategy.
  5. Retirement

    6 Ways To Maximize The Value Of Your 401(k)

    From matching employer contributions to proper asset allocation, we'll tell you how to get the most out of your plan.
  6. Markets

    Negative Interest Rates Require Flexibility in Fixed Income

    Here’s a quick look at four charts showing just a few of the interrelated ways the global fixed income markets have dramatically changed over the last seven years.
  7. Economics

    Understanding Game Theory

    Game theory is a model for making decisions that weighs the benefits of a choice along with the interaction between participants.
  8. Economics

    Understanding Imperfect Competition

    Imperfect competition appears in several different forms. Markets are evaluated by how they compare to, and try to approach, perfect competition.
  9. Investing

    What Happens to Bond ETFs in Stressed Markets?

    We are going to dive a little deeper today at how bond exchange traded funds (ETFs) fare when the markets are stressed.
  10. Economics

    Explaining Cost Of Capital

    Cost of capital is the cost of funds used to finance a business.
RELATED FAQS
  1. Which is better: dollar cost averaging or value averaging?

    Compare the two investment strategies of dollar cost averaging and value averaging, and learn which one usually generates ... Read Answer >>
  2. What is finance?

    "Finance" is a broad term that describes two related activities: the study of how money is managed and the actual process ... Read Answer >>
  3. What is the difference between positive and normative economics?

    Positive economics is objective and fact based, while normative economics is subjective and value based. Positive economic ... Read Answer >>
  4. What is the utility function and how is it calculated?

    Learn what the utility function is in microeconomic theory and how it is calculated based on a functional form that represents ... Read Answer >>
  5. How can I use a regression to see the correlation between prices and interest rates?

    Learn how to use linear regression to calculate the correlation between stock prices and interest rates by taking the square ... Read Answer >>
  6. Over what period should I use dollar cost averaging?

    Learn why dollar cost averaging should be implemented over a period of time that is 12 months or less in order to avoid missing ... Read Answer >>
Hot Definitions
  1. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  2. Society for Worldwide Interbank Financial Telecommunications ...

    A member-owned cooperative that provides safe and secure financial transactions for its members. Established in 1973, the ...
  3. Generally Accepted Accounting Principles - GAAP

    The common set of accounting principles, standards and procedures that companies use to compile their financial statements. ...
  4. DuPont Analysis

    A method of performance measurement that was started by the DuPont Corporation in the 1920s. With this method, assets are ...
  5. Call Option

    An agreement that gives an investor the right (but not the obligation) to buy a stock, bond, commodity, or other instrument ...
  6. Economies Of Scale

    Economies of scale is the cost advantage that arises with increased output of a product. Economies of scale arise because ...
Trading Center