If you know about dollar-cost averaging (DCA), value averaging is its more sophisticated cousin. While DCA invests a fixed dollar amount every period, value averaging adjusts the amount based on how your portfolio is performing.
How Value Averaging Works
With value averaging, you set a target growth rate for your portfolio. Each period, you invest whatever amount is needed to hit that target.
Example with a $500/month target growth:
Month 1: Portfolio should be $500. It is $0. You invest $500. Month 2: Portfolio should be $1,000. It grew to $550. You invest $450. Month 3: Portfolio should be $1,500. It dropped to $900. You invest $600. Month 4: Portfolio should be $2,000. It grew to $1,800. You invest $200.
When the market is down, you invest more (buying at lower prices). When the market is up, you invest less (or even sell a small amount if the portfolio exceeds the target).
Value Averaging vs Dollar-Cost Averaging
| Feature | DCA | Value Averaging |
|---|---|---|
| Amount invested | Same every period | Varies by performance |
| Buys more when prices are low | Yes (automatically) | Yes (by design, more aggressively) |
| Complexity | Very simple | More complex |
| Cash flow predictability | Predictable | Unpredictable |
| Historical performance | Good | Slightly better in some studies |
The Advantages
Buys low more aggressively. When prices drop, value averaging requires larger investments, which means you accumulate more shares at lower prices.
Mechanical discipline. The formula tells you exactly what to do each period. No emotional decision-making.
Historically slightly better returns. Academic studies have shown value averaging can produce modestly better risk-adjusted returns than DCA, though the difference is not dramatic.
The Disadvantages
Unpredictable cash requirements. During market downturns, value averaging may require you to invest significantly more than planned. If you do not have the cash available, the strategy breaks down.
More complex to implement. DCA is automatic and simple. Value averaging requires calculation and adjustment each period.
Can require selling. In strong market periods, the strategy may tell you to sell, which triggers capital gains taxes in taxable accounts.
Which Should You Use?
For most beginners, DCA is the better choice because of its simplicity and predictable cash requirements. Value averaging is worth considering if you have variable income, a cash reserve to draw from, and want to be more systematic about buying more during downturns.
Either approach is vastly better than trying to time the market.
The Progressive Trailblazer includes a DCA Simulator and What-If tools for modeling different investment strategies. Educational only. Not financial advice.