Value Averaging

Value averaging (VA) is an investment approach that adjusts periodic contributions to hit a predetermined target portfolio value path. Unlike dollar-cost averaging (DCA), which invests a fixed amount each period, VA raises or lowers the contribution so the total portfolio reaches a target amount (for example, increasing by $1,000 each quarter). If the portfolio is ahead of the target, you invest less or may withdraw; if it is behind, you invest more.

Key takeaways

• VA targets a planned growth path for portfolio value and adjusts contributions to meet it.
• You buy more when prices fall and less when prices rise, concentrating purchases at lower prices.
• Over long periods, studies show VA can slightly outperform DCA, but both broadly track market returns.
• VA can become capital-intensive as the portfolio grows and may be impractical in some accounts or market downturns.

How value averaging works

1. Choose a target growth path — a fixed dollar increase or a percentage growth for each period.
2. At each interval, calculate the target portfolio value for that period.
3. Compare the target to the actual portfolio value.
4. If actual < target: contribute the difference (buy more shares).
5. If actual > target: contribute less or withdraw the difference (or sell holdings to realize gains).
6. Repeat each period to keep the portfolio on the planned path.

This method concentrates contributions when prices are lower (buying more shares) and reduces contributions when prices are higher (buying fewer shares or selling), which can improve long-term returns versus a fixed-contribution plan.

Example

Start: $1,000 initial portfolio (100 shares at $10). Target: increase portfolio value by $1,000 each quarter.

• Quarter 2: Price rises to $12.50 → portfolio = 100 × $12.50 = $1,250.
  Target = $2,000 → required contribution = $2,000 − $1,250 = $750.
  At $12.50/share you buy 60 shares → total 160 shares × $12.50 = $2,000 (meets target).

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• Next quarter: target $3,000, and the process repeats (contribute or withdraw to hit that new target).

Advantages

• Encourages buying more at lower prices and fewer shares at higher prices.
• Forces discipline and a consistent investment plan.
• Can produce modestly higher returns than fixed contributions in some long-term studies.
• Can act as a systematic rebalancing mechanism when you withdraw excess value.

Challenges and risks

• Funding shortfalls can become large as the portfolio grows — requiring substantial cash or margin.
• In a prolonged down market, investors may run out of funds to meet increasing targets.
• Contribution limits (e.g., retirement accounts) can make VA impractical.
• Transaction costs and tax implications arise when selling to meet targets.
• More complex and administratively demanding than DCA.

Practical workarounds and tips

• Hold a fixed-income or cash sleeve and draw from it to fund equity shortfalls instead of adding new cash.
• Set maximum contribution limits or pause VA during extreme market stress to avoid depletion.
• Use VA within accounts where contributions and withdrawals are tax-efficient.
• Consider a hybrid approach: use DCA for new money and VA for portions of the portfolio where you can fund variability.
• Track expected versus actual funding needs and maintain an emergency fund to avoid forced selling.

Conclusion

Value averaging is a disciplined strategy that systematically shifts contributions to buy more when prices are low and less when prices are high. It can improve the timing of purchases compared with fixed contributions, but it demands greater funding flexibility, monitoring, and sometimes selling, which can create practical and tax challenges. Investors should weigh the potential incremental benefit against the added complexity and funding risk before adopting VA.