What is 'Value Averaging'

Value averaging is 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 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.

Pitfalls of Value Averaging

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. Shortfall

    A shortfall is an amount by which a financial obligation or liability ...
  2. Strategic Asset Allocation

    Strategic asset allocation is a portfolio strategy that involves ...
  3. Dollar-Cost Averaging (DCA)

    Dollar-cost averaging is the system of regularly procuring a ...
  4. Implementation Shortfall

    An implementation shortfall is the difference between the price ...
  5. Value Fund

    A value fund is a fund that follows a value investing strategy ...
  6. Fund Category

    A fund category is a way of differentiating mutual funds according ...
Related Articles
  1. Trading

    Choosing between dollar-cost and value averaging

    Learn more about dollar-cost and value averaging, two investing methods that seek to counter our natural inclination toward market timing.
  2. 6 Asset Allocation Strategies That Work

    Your portfolio’s asset mix is a key factor in its profitability. Find out how to achieve this delicate balance.
  3. Managing Wealth

    Achieve Optimal Asset Allocation

    Minimize risk while maximizing return with the right mix of securities and achieve your optimal asset allocation.
  4. Investing

    What Is Strategic Asset Allocation?

    A strategic asset allocation takes a long-term approach to help an investor achieve their financial goals. Here's how it works.
  5. Investing

    7 Simple Strategies for Growing Your Portfolio

    There are many ways to grow the value of a portfolio. These seven tried-and-true methods to increase returns have been used by investors of all stripes.
  6. Investing

    American Funds American Balanced Fund Performance Case Study (ABALX)

    Explore the performance of the American Funds American Balanced Fund, including how the fund limits volatility, as well as regular patterns of buying and selling.
  7. Managing Wealth

    Choose Your Own Asset Allocation Adventure

    There are many strategies to help balance your portfolio. Here are a few to get you started.
  8. Investing

    What Is Tactical Asset Allocation?

    Here's how tactical asset allocation, an extension of strategic asset allocation, works.
  9. Investing

    The Benefits of Dollar-Cost Averaging Explained

    Implementing dollar-cost averaging as an investment strategy has several benefits.
Hot Definitions
  1. Business Cycle

    The business cycle describes the rise and fall in production output of goods and services in an economy. Business cycles ...
  2. Futures Contract

    An agreement to buy or sell the underlying commodity or asset at a specific price at a future date.
  3. Yield Curve

    A yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but ...
  4. Portfolio

    A portfolio is a grouping of financial assets such as stocks, bonds and cash equivalents, also their mutual, exchange-traded ...
  5. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
  6. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
Trading Center