The Value Averaging Strategy

The value averaging strategy is an investment method that many investors have turned to. This is often done in place of using dollar cost averaging as an investment strategy. Here are the basics of the value averaging strategy and what it can do for you as an investor.

The Value Averaging Strategy

The value averaging strategy is a method that regulates the way you purchase securities for your portfolio. With this method, you will choose particular securities to purchase on a regular basis. At the beginning of the process, you will set a specific amount that you want your account to increase by each period. For example, you might say that you want the value of your account to go up by $300 every month. This increment will determine how much of a particular security you purchase at the end of the month.

Let's say that you start out with $300 in an investment account. You purchase shares of a mutual fund with this money. At the end of the first month, the value has gone up to $320. Therefore, at the beginning of the next month, you would deposit $280 into the investment account. This would make the new balance $600, and it would accomplish your goal of increasing the account by an increment of $300 per month. The following month, the value of your account goes down to $580. At that time, you would have to deposit $320 to your account. That would get you to $900 total in your account.

Therefore, when your investments do well, you will put less money into your account. When the prices of the securities go down, you will have to come up with more money for that particular period. 

Advantages

This type of investment strategy can present you with a few advantages over other types of investments. With this strategy, you are buying more shares of securities whenever they are cheaper and fewer of them when they are more expensive. By using the strategy, you will be able to realize potentially greater returns than you would with other methods. You will not be spending your dollars on more expensive securities, but you will be saving them for when the price drops. According to several different studies, this method can increase your returns over the traditional dollar cost averaging method.

Disadvantages

Although this strategy has been proven to work, it does come with some drawbacks. One of the biggest drawbacks associated with this type of plan is that it sometimes requires you to come up with a substantial amount of money to make up for losses. If during a certain period, you lose a great deal of money, you will have to come up with that money out of your pocket in order to meet your incremental goal. If you are investing in a retirement account, this may not even be possible. You have yearly contribution limits that must be adhered to. Therefore, when you hit your investing limit, you will not be able to contribute any more.

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