Value Averaging
Candlefocus EditorValue averaging essentially works on the principle of buying-low and selling-high. When the portfolio value falls below the predetermined amount from the initial plan, more money is added to the portfolio. This puts downward pressure on the investment to catch up to the predetermined amount. Conversely, when the portfolio value increases beyond the predetermined amount, the investor reduces their investment until the portfolio drops back down to the predetermined amount.
Investors who practice value averaging keep track of their “target value” each period and adjust the investment amount accordingly. A target value is a predetermined portfolio value, set at a certain period. In order to practice this strategy, investors are advised to use either a pre-determined investment plan or develop a “value growth” plan.
A pre-determined investment plan involves calculating the total value of a portfolio if the investor were to buy the same asset at a fixed price each period. Then, each period the investor adjusts the amount of money to be invested so that when combined with the purchased at the predetermined value level, the total portfolio value equals the predetermined amount.
A “value growth” plan adjusts the periodic purchase amounts in a similar manner but differs in that the target value can increase or decrease each period. In this case, the investor releases the planned amount for the purchase of assets in each period as long as the total portfolio value does not exceed the pre-determined value of the investment.
In addition to these two plans, investors may also use a combination of the two. Value averaging is often seen as a way to smoothen out the volatility in a portfolio and to reduce the risk associated with market movements. With value averaging, the investor reduces their risk of large losses due to sudden market movements while at the same time trying to grow their investments with the desired return rate.
Overall, value averaging is an investment strategy that allows investors to adapt to changing market conditions, while still attempting to achieve the planned return rate. By making regular investments and adjusting their contributions, investors can take advantage of lower-prices assets and attempt to maximize their returns.