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. Strategic Asset Allocation

    Strategic asset allocation is a portfolio strategy that involves ...
  2. Asset Allocation Fund

    An asset allocation fund is a fund that provides investors with ...
  3. Interest Shortfall

    An interest shortfall is the monthly interest that remains due ...
  4. Value Fund

    A value fund is a fund that follows a value investing strategy ...
  5. Asset Mix

    Asset mix is the breakdown of all assets within a fund or portfolio. ...
  6. Pension Shortfall

    A pension shortfall occurs when a company with a defined benefit ...
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. Investing

    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 with a few optimal strategies for asset allocation.
  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

    BlackRock Global Allocation Fund Performance Case Study (MCLOX)

    Explore the performance of the BlackRock Global Allocation Fund since 2012, including a summary of how currency fluctuations affected yearly returns.
  5. 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.
  6. Investing

    3 Ways to Prepare for a Market Downturn

    No one knows when a market downturn will occur or how long it will last, so it pays to be prepared.
  7. Investing

    5 Tips to Increase the Performance Of Your Portfolio

    Discover helpful steps an investor can easily take to improve the performance of his investment portfolio by maximizing gains and minimizing losses.
  8. Investing

    What Is Tactical Asset Allocation?

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

    Pros & Cons Of Dollar Cost Averaging

    The dollar-cost averaging approach helps investors avoid market timing but they give up some potential for higher returns.
Trading Center