is a strategy that combines the best bits of rand cost averaging
with the benefits of rebalancing
. Michael Edleson, a former chief economist at stock exchange group NASDAQ, published it in his book.
With value averaging, you don’t invest a fixed sum of money each month or quarter. Instead, the aim is to grow the value of your portfolio by a set amount.
For instance, instead of investing R1,000 a month via rand cost averaging, you aim to grow your portfolio’s value by R1,000 a month.
But over the longer run, basic value averaging doesn’t do as well, Phil Oakley explains in MoneyWeek
You need more than value averaging over the long haul
That’s because as the size of the portfolio rises, you need to adjust the desired increase in value.
So you need to tinker with the strategy a little to make it work by creating a ‘value path’.
Edleson’s book has a useful spreadsheet to help you work this out. Let’s say you work out that you need R5 million to retire. You plan to save for 30 years, assuming returns of 6% a year, with your contributions growing by 3% a year.
After one year the target value of your portfolio is R45,310; after ten years, R678,760; and R2,127,220 after 20 years.
In other words, the value path just tells you what value your portfolio has to be to stay on track at any given point in time.
You then buy and sell things accordingly.
That makes this a particularly good strategy for meeting a savings target – it forces you to work out your end goal, then work backwards to achieve it.
The disadvantages of using a value path
Of course, it does have some drawbacks.
Not every strategy works all the time.
And it requires much more monitoring of your portfolio and could end up costing more money due to regular buying and selling.
Depending on how volatile the markets are, you may end up having to make very big investments from time to time to keep the value of the portfolio on track.
Also, selling chunks of a big portfolio may trigger capital-gains taxes.
How to map your value path
Work out how much money you need to retire – use an online calculator.
Create your value path.
Review your portfolio no more than every three months.
Put proceeds of sold investments in a savings account to draw on later.
So there you have it, how to map out a value path to riches.