Value averaging is a technique of adding to an investment portfolio to provide greater return than similar methods such as dollar cost averaging and random investment. It was developed by former Harvard University professor Michael E. Edleson.
Value averaging is a formula based investment technique whereas mathematical formula is used to guide the investment of money into a portfolio over time. With the method, investors contribute to their portfolios in such a way that the portfolio balance increases by a set amount, regardless of market fluctuations.
As a result, in periods of market declines, the investors contributes more, while in periods of market climbs, the investor contributes less. In contract of dollar cost average which mandates that a fixed amount of money be invested at each period, the value averaging formula to identify periods of investment over-performance and under-performance vs. expectations.
After the investment has over performed, the investor will be required to buy less or sell. After the investment has underperformed, the investor will be required to buy more (buying low). Some research suggests that the method results in higher returns at a similar risks, especially for high market variability and long time horizons.
The first step of any investment program is always the hardest, and individual investors taking their first steps in an investment program must also confront a sea of stock market uncertainty. Some plunge headlong into the market with all their savings. Others barely wet their feet before heading back to the safe shores of their fixed income deposits and money mutual funds. The problem with these two approaches is one of timing - the risk of entering the market is at a high point in the market cycle.
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