After learning Dollar Cost Averaging (DCA), a second similar strategy provides the next step into the world of investing.
Dollar Value Averaging (DVA), or just Value Averaging (VA), provides a number of advantages over Dollar Cost Averaging and a number of disadvantages.
The main advantages are:
- more money is invested when prices are low
- less money is invested when prices are high
- the model also includes opportunities to sell when prices are high
The disadvantages will be discussed at the end, where it will be possible to explore methods of mitigation.
What is Value Averaging?
Value Averaging can be summarized succinctly: at a fixed time interval, purchase a fixed value of a predetermined asset.
Instead of putting the same amount of money into the investment every time, the amount of money invested is only enough required to bring the total up to the target value.
That probably doesn’t make a lot of sense, so let’s work through an example.
An Example of How it Works
Let’s say we set a target value of $100 and a time period of 1 week.
That means, every week I want the value of the stake in the asset to $100 more than the previous week.
| Time Period | Target Value |
|---|---|
| Week 1 | $100.00 |
| Week 2 | $200.00 |
| Week 3 | $300.00 |
| … | … |
We’ll walk through 5 weeks to see how this VA handles different circumstances.
In time period 1, I own no units of the asset, and so I purchase 100% of the target value
| Time Period | Target Value | Price | Current Units | Current Value | Units to Purchase | Total Units |
|---|---|---|---|---|---|---|
| Period 1 | $100.00 | $10.00 | 0.0000 | $0.00 | 10.0000 | 10.0000 |
In the next time period, the value of the asset has dropped and I purchase a little more to get to the $200 target value, as illustrated in the next table.
Purchasing more units when the price is down is in line with the adage, “Buy low”.
| Time Period | Target Value | Price | Current Units | Current Value | Units to Purchase | Total Units |
|---|---|---|---|---|---|---|
| Period 1 | $100.00 | $10.00 | 0.0000 | $0.00 | 10.0000 | 10.0000 |
| Period 2 | $200.00 | $9.00 | 10.0000 | $90.00 | 12.2222 | 22.2222 |
In time period 3, the price has gone up and my units are worth $244.44.
Since my target value is $300, I need only purchase 5.0505 units.
Purchasing fewer units when the price is high is in line with the adage, “Sell high”.
| Time Period | Target Value | Price | Current Units | Current Value | Units to Purchase | Total Units |
|---|---|---|---|---|---|---|
| Period 1 | $100.00 | $10.00 | 0.0000 | $0.00 | 10.0000 | 10.0000 |
| Period 2 | $200.00 | $9.00 | 10.0000 | $90.00 | 12.2222 | 22.2222 |
| Period 3 | $300.00 | $11.00 | 22.2222 | $244.44 | 5.0505 | 27.2727 |
Then in time period 4, the price goes down again and more units are purchased.
| Time Period | Target Value | Price | Current Units | Current Value | Units to Purchase | Total Units |
|---|---|---|---|---|---|---|
| Period 1 | $100.00 | $10.00 | 0.0000 | $0.00 | 10.0000 | 10.0000 |
| Period 2 | $200.00 | $9.00 | 10.0000 | $90.00 | 12.2222 | 22.2222 |
| Period 3 | $300.00 | $11.00 | 22.2222 | $244.44 | 5.0505 | 27.2727 |
| Period 4 | $400.00 | $9.50 | 27.2727 | $259.09 | 14.8325 | 42.1053 |
At this point, let’s stop and compare how VA compares with DCA.
The following table shows the same periods for Dollar Cost Averaging.
| Time Period | Purchase Amount | Price | Units to Purchase | Total Units |
|---|---|---|---|---|
| Period 1 | $100.00 | $10.00 | 10.0000 | 10.0000 |
| Period 2 | $100.00 | $9.00 | 11.1111 | 21.1111 |
| Period 3 | $100.00 | $11.00 | 9.0909 | 30.2020 |
| Period 4 | $100.00 | $9.50 | 10.5263 | 40.7283 |
Despite the simplicity of this example, the benefits of Value Cost Averaging are already visible.
Dollar Cost Averaging will have purchased 40.7283 units of the asset.
Value Averaging, on the other hand, will have purchased 42.1053.
Due to the simplicity of the tables above, it is not immediately clear that Value Averaging’s total cost was $406.46.
The average unit was, therefore, purchased for $9.65.
The total cost of Dollar Cost Averaging was $400 and so the average unit was purchased for $9.82.
Returning to our example, in week 5 the price suddenly spikes.
Cryptocurrency and penny stock enthusiasts may recognize such a move.
| Time Period | Target Value | Price | Current units | Current Value | Units to Purchase | Total Units |
|---|---|---|---|---|---|---|
| Period 1 | $100.00 | $10.00 | 0.0000 | $0.00 | 10.0000 | 10.0000 |
| Period 2 | $200.00 | $9.00 | 10.0000 | $90.00 | 12.2222 | 22.2222 |
| Period 3 | $300.00 | $11.00 | 22.2222 | $244.44 | 5.0505 | 27.2727 |
| Period 4 | $400.00 | $9.50 | 27.2727 | $259.09 | 14.8325 | 42.1053 |
| Period 5 | $500.00 | $15.00 | 42.1053 | $631.58 | -8.7719 | 33.3333 |
Instead of continuing to blindly purchase more of the asset, Value Averaging provides a sell signal.
Many beginning investors find this moment to be a bit of a conundrum, wondering if they should sell, and if so, how much.
VA provides us provides the exact amount to sell: 8.7719 units.
This additional cash can then be reinvested when the price of the asset drops.
What is the Downside?
So, if Value Averaging is so much better, why doesn’t everyone use it?
Well, there are some disadvantages.
The first being, it’s much harder to explain to other people.
It’s also harder to automate.
So it isn’t ideal as a beginning strategy.
Also, as time goes on, the fluctuations between periods can become quite extreme.
This can end up requiring massive purchases or sale of an entire stake.
Given the circumstances, this can be counter-productive or investment saving.
A number of strategies can be employed to reduce this risk.
These are beyond the scope of this posting.
Finally, Dollar Cost Averaging is better suited for the beginning investor who is slowly building a stake with regular infusions of cash.
Value Averaging requires a pool of money to be held as cash so that larger purchases can be made.
Since the pool of money is not invested, there is an opportunity cost associated with the strategy.
Thus, it is a tool best used by a more experienced investor with at least some excess resources.