Value Averaging

AS AN ALTERNATIVE to dollar-cost averaging, consider value averaging, a strategy developed by a former Harvard Business School professor, Michael Edleson, and described in his 1993 book Value Averaging.

The math involved is fairly complicated. But the idea is simple enough: You set a target growth rate for your stock portfolio and then vary your regular investment, depending on how your stocks perform. Let’s say you want your portfolio to grow $500 a month. A month after you make your first $500 investment, your stock portfolio is worth $526. That means that, in the second month, you would need to invest $474 to hit your target portfolio value of $1,000. You might stash the other $26 in a money-market fund.

That cash in a money-market fund could come in handy if there’s a spell when the market performs poorly and you need to invest substantially more than $500 each month. On the other hand, if the market enjoys a strong run, you could find yourself selling stocks to keep your stock portfolio on that $500-a-month growth path. That selling could trigger capital gains taxes and some messy tax accounting, but you can sidestep those problems by value averaging within your retirement accounts.

Like dollar-cost averaging, value averaging compels you to buy more shares when the market is depressed and fewer shares when it’s buoyant. But with value averaging, the effect is even stronger. Indeed, value averaging can be seen as a cross between dollar-cost averaging and rebalancing, a concept we’ll tackle when we discuss investing in greater depth.

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