What it means
With value averaging, the investor chooses a growth path for the portfolio, for example an increase of $500 in value every month. At each date the investor compares the actual value of the holdings with the target for that date and puts in the difference.
When prices have fallen, the portfolio is below target and the investor buys more units. When prices have risen, the portfolio is closer to or above target, so the investor buys fewer units, buys none, or in some versions sells the excess.
The result is a built-in habit of buying more when prices are low and less when they are high. The better-known alternative is dollar-cost averaging, where the same amount is invested at each date regardless of price.
Value averaging tends to give a slightly lower average cost per unit in volatile markets, but it requires more attention and a larger cash reserve for the months when prices drop and the required contribution jumps. Practical costs matter.
Frequent trades can generate fees and, in a taxable account, taxes when units are sold, which can wipe out the benefit. Many investors therefore use the no-sale version, which only pauses contributions when the portfolio is ahead of target.
The method is not limited to individuals. A business treasurer building a long-term reserve, a charity growing an endowment, or an owner investing surplus cash can all use a target path to bring discipline to when and how much they invest.
It is also worth being clear about what it does not do. It does not guarantee a profit, it does not remove market risk, and the choice of the target growth path is a judgement that strongly affects how much cash is needed.
In practice
Real-world examples.
Example
A freelance designer wants to build an investment fund of $24,000 over four years. She sets a target path of $500 more value each month and invests the difference. In months when the market drops she invests more, and in strong months she invests little.
Example
A charity's finance committee decides to build a reserve fund by $50,000 a quarter. When a market fall leaves the fund $18,000 below target, the committee approves a larger contribution that quarter. The treasurer keeps cash set aside so that the larger payments can be met.
Example
A manufacturer's owner invests surplus profits in an index fund using a no-sale rule. After a strong year puts the fund ahead of its target, he makes no contribution for two months. He resumes contributions when the market falls back below the target line.
Formula
Calculation
Contribution for the period = Target portfolio value for the period - Current value of holdings before investing
An investor sets a target of $500 of growth each month. In month 1 the target is $500 and the holdings are worth $0, so the contribution is $500. In month 2 the target is $1,000. The fund has fallen 6%, so the $500 held is now worth 500 x 0.94 = $470, and the contribution = 1,000 - 470 = $530. In month 3 the target is $1,500. The fund has risen 10%, so the $1,000 held is worth 1,000 x 1.10 = $1,100, and the contribution = 1,500 - 1,100 = $400. Total invested = 500 + 530 + 400 = $1,430, and the portfolio is worth $1,500 after the month 3 purchase.Case study
Seen in the real world.
Tidewater Bakery is an illustrative, fictional business whose owner invests a part of its annual profit in a diversified fund for retirement. For years she invested a flat $2,000 every month and felt she was buying the same amount whether prices were high or low.
She switched to value averaging with a target growth of $2,000 a month. In a quarter when the fund dropped, the required contribution rose to $3,400 in one month, and she funded it from a cash reserve she had built for the purpose.
In the illustrative result, she bought more units at lower prices and fewer when the market was strong, and her average cost per unit ended up below the simple average price over the period. She also learned that the method needs a cash buffer and a clear rule for months when the contribution is very large.
Watch out
Common mistakes.
- Assuming value averaging guarantees better returns than a fixed monthly purchase, when it only changes the timing of purchases and still carries full market risk.
- Setting a target growth path that is too ambitious, which forces very large contributions after a market fall.
- Ignoring trading costs and taxes in a taxable account, which can cancel the benefit of selling units when the portfolio is ahead of target.
Questions
People also ask.
How is value averaging different from dollar-cost averaging?
Dollar-cost averaging invests the same amount each period, whereas value averaging adjusts the amount so that the portfolio value follows a set path.
Do I have to sell when the portfolio is above target?
No, many investors use a version that simply skips the contribution, which avoids trading costs and tax.
Is the method suitable for a company?
It can be, for long-term reserves and endowment-style funds, provided the treasurer keeps enough cash available for the larger contributions that falls in the market can require.
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