Value Averaging: The safe and easy investment strategy for higher investment returns: Book Notes

This post has my personal notes from the book, Value Averaging by Michael Edelson.

1. Historically, the stock market has given the highest returns over very long periods of time compared to other asset classes like corporate bonds, government bonds and treasury bills. This is likely to be the case in the future as well. It would be nice if we could all buy when prices are low and sell when prices are high. But this is not possible. But rather than buy when prices are high and sell when prices are low, one can do better by following formula strategies which help us do automatic timing.

2. Dollar cost averaging is a simple and effective strategy for accumulating investment wealth over time. It is based on a simple principle: Invest the same amount of money each time period, regardless of price.

The other method one can use is called the constant share strategy. This means buying the same amount of shares each time period, regardless of price.

One important thing to understand it that dollar cost averaging do not take into account two things: inflation and the growth rate of the stock market. So it will be better to adjust the amount we invest for inflation or growth rate of the stock market. Adjusting for growth of the market produces better results usually.

  • If we say, the average long-term inflation rate is 5% per year, we can increase the amount invested 5% every year. This means if you invest $100 per month in the first year, you will invest $105 per month in the second year, $110.25 in the third year and so one.
  • If we say the average long-term growth rate of the stock market is 10% per year, we can increase the amount invested 10% every year.This means if you invest $100 per month in the first year, you will invest $110 per month in the second year, $121 in the third year and so on.

Investing a constant amount of shares is also a good method but you might need more money to invest each time period because of the long-term uptrend of the stock market.

So there are four strategies:

  1. Simple dollar cost averaging
  2. Inflation-adjusted dollar cost averaging
  3. Stock market growth rate adjusted dollar cost averaging
  4. Constant share purchase strategy.

3. Value averaging is a formula strategy where the rule is to make the value of your stock holding go up by a fixed amount ( say $100) or fixed percentage( say 1%) every time period. If the mount goes up more than that, you can sell the extra. If the amount goes up less than that, you have to invest more. Similar to dollar cost averaging this will work well if you adjust for inflation or growth rates( better). All the strategies will work better if you use percentage amounts and not fixed amounts.

4. You can also use what is called a no-sell value averaging formula. This means you never sell your holdings if the price overshoots your predetermined value. This will give lower returns than a pure value averaging strategy but will give better returns than a dollar cost averaging strategy. You can also use a delay selling strategy( say sell only if price shoots for a particular number of months or based on tax savings). You can also not buy or sell small amounts to reduce transaction costs and value average quarterly rather than monthly.

5. When you sell the stocks, the money has to go into a side fund. This can be a short-intermediate term bond fund or just cash.

6. You also have to remember that with a no sell value averaging or even with dollar cost averaging you might end up with more total money even though the annual percentage return may be lower. This is because the amount you actually invest is more in these strategies.

7. It looks quarterly periods of investing are better than monthly periods of investing based on historical returns.

8. Although there are a lot of complicate formulas in the book, the essential principles are simple.

  • How much money you are going to invest initially?
  • At what time intervals you are going to invest?
  • How long you are going to do this?
  • What is percentage increase you are going to set for your time period( monthly, quarterly, yearly)?. This percentage increase should incorporate both inflation rate+ growth rate?
  • Are you going to use a pure value averaging strategy or a no-sell value averaging strategy?
  • Do you have a known terminal amount you are targeting or you want to accumulate as much as you can. If you have a terminal amount you need to make sure this is adjusted for inflation.If you want to accumulate as much as you can, a no sell value averaging strategy may be a better strategy than a pure value averaging strategy. A dollar cost averaging strategy is also useful in this scenario.

9. If you know the terminal amount, the initial amount and the duration you can find out what percentage increase you need each year and you can plan your value averaging based on that. This formula can help:Say your initial amount is $10,000 dollars, your final amount is $1000000 and you want to achieve it in 40 years. Your CAGR needs to be 12.2%. So each year your amount needs to increase by 12.2%. So after 1 year your $10,000 should have grown to $11220. If it has grown beyond $11220 you can sell the extra and keep it in a separate account. If it has fallen short, then you need to invest more for the shortfall.

10. If you know the initial amount, the regular deposits, the growth rate, and the time you are going to be invested you can calculate what amount you will get. So if you invest 1000 dollars every year at 12% growth rate for the next 20 years you will get $90345.03. You can use this calculator to calculate this.If you think this is enough, then at the end of year one $1000 should have grown to $1120 after year one. Then you add 1000 dollars more to make it $2120. This has to grow at 12% next year. This has to grow to 2332 at the end of year 2. Then you add 1000 dollars more and so on. If you achieve more than your predetermined target you can sell, invest less than 1000 dollars or do nothing( if adopting a no sell value averaging policy). If you achieve less than your predetermined target you have to invest more than 1000 dollars to make up for the short fall.

11. To summarise, dollar cost averaging, constant share purchase and value averaging are three strategies discussed in the book. You have use growth/inflation adjusted strategies with dollar cost or value averaging. The principles are simple and can be easily applied.

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