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By Keith Fitz-Gerald
Money Morning/The Money Map Report
If you're like most investors whose portfolios have been pounded in recent months, you've got some losses to make up for. And while the outlook appears more promising than before with the U.S. Federal Reserve ready to ride to the rescue, you might be wondering just how you're going to recoup those lost profits.
Here's an easy, yet relatively painless strategy that we've advocated in our sister publication, The Money Map Report. Investors can make up their market losses using a simple technique called "value averaging."
What It Is
Just in case you are not familiar with the term "dollar cost averaging," it's simply a means of accumulating investment assets by buying the same dollar amount of shares at some predetermined regular interval, regardless of the market price at that time.
For example, a neighbor of mine invests $100 a month – like clockwork – in his favorite mutual fund. By definition, this means that he buys more shares when the prices are lower [like now] and fewer shares when the prices are higher. Over the long run, his cost is likely to be lower than it would be if he just bought an equivalent number of shares in a single transaction.
In essence, he is "averaging" his purchases over time, and reducing the risk of buying at the "wrong" [i.e. "high"] price, hence the term "dollar-cost averaging."
How it Differs and Why it Works
"Value averaging" is a little different. Whereas my neighbor decides to invest his $100 a month, I prefer to grow my portfolio by a fixed amount every month. For discussion purposes, let's assume that I want to make my portfolio grow by $100 a month – every month. In some months, I would invest $100 just like my neighbor. However, if the $100 I have contributed last month lost a bit of ground and is now only worth $90, I'll contribute $110 next month to make up the difference.
In the months where I have made more than my target, I might not contribute anything at all.
This simple twist, first proposed by its creator, former Nasdaq Chief Economist and Harvard Business School Professor Michael E. Edleson, has been shown to produce better results over time than the old "dollar-cost averaging" method.
Edleson, who is now a managing director at Morgan Stanley (MS), relied on one crucial piece of information that was missing from the "dollar-cost averaging" method to come up with "value averaging." By considering a portfolio's expected rate of return [something that the "dollar-cost averaging" method neglects], the "value averaging" method helps to identify periods of over- and underperformance.
When the portfolio is underperforming, share prices are likely to be low. And that's when you'll be investing more to make up for the underperformance. When the portfolio is outperforming your target-rate return, share prices are likely to be high. That means it is not a good time to buy and you could even sell for a profit, provided you maintain your predetermined average growth rate.
"Value averaging" is a nice way to ensure you follow one of the most well known investment mandates: Buy low and sell high. The method is particularly valuable during times of high volatility to help ensure investors maintain discipline in their investing. And in these difficult market conditions, it's certainly worth considering.
News and Related Story Notes:
Dollar Cost Averaging.
- Web Site:
Harvard Business School.
Value Averaging Basics.
About the Author
Keith Fitz-Gerald has been the Chief Investment Strategist for the Money Morning team since 2007. He's a seasoned market analyst with decades of experience, and a highly accurate track record. Keith regularly travels the world in search of investment opportunities others don't yet see or understand. In addition to heading The Money Map Report, Keith runs High Velocity Profits, which aims to get in, target gains, and get out clean. In his weekly Total Wealth, Keith has broken down his 30-plus years of success into three parts: Trends, Risk Assessment, and Tactics – meaning the exact techniques for making money. Sign up is free at totalwealthresearch.com.