The technique of value averaging was first promulgated by former Harvard professor, Michael E. Edelson, in his book, Value Averaging. published by Wiley in 1988. [1]. Conceptually, value averaging can be thought of as combining the attributes of both dollar cost averaging and portfolio rebalancing. Value averaging is based on a formula (below) which guides how much one invests into a given investment at a specific time. Value averaging seeks to increase the investment’s value by this calculated amount on a periodic basis. [2]

Contents

Methodology

The key idea is to create a Value Path which will describe the investment’s target level for each time period. You must simply make the proper investment or sale at each period so that the holdings are equal to the target value. Let’s define our variables and show the formula for the Value Path. [3]

Table 1: Variables

• t = Time period (can be months, quarters, years, etc.)
• V_t = Target value of investment at time period t
• C = Target initial contribution per period
• r = Expected rate of growth per period of investment
• g = Expected rate of growth per period of contribution
• R = Average rate of growth of investment and contribution

To simplify the math, we will set R=(r+g)/2. Thus, R is just an average of the growth rates of the investment and the contribution amount.

Now, the formula for the Value Path:

V_t = C * t * (1+R) t

Now, you can simply use this formula to generate a Value Path for your investment. There are two different approaches for this depending on your needs. If you have a specific goal in mind, like you need $100,000 in 10 years for your son’s college expenses, you can start with the final value of the Value Path and use that to determine the required value of your initial contribution (C). So, for our example, if we were working with monthly time periods, we would want V₁₂₀ = 100,000. Then, we solve V₁₂₀ = C * 120 * (1+R) 120.

On the other hand, if you have no specific savings goal but do know the amount of initial contribution that you are comfortable with, then you can plug in a value of C and solve for all the values of V_t.

We would suggest using Excel to create your Value Paths and track your progress. An important thing to remember about the Value Path is that you should remain flexible and update your Value Path if circumstances change. For instance, if the rate of growth for your investment or your ability to contribute changes, you should re-calculate the Value Path from your current point.

The Value Path formula depends heavily on your estimates of the rate of growth of the investment asset. Thus, it’s very important to provide as realistic rates as possible.

Illustrative example

The following spreadsheet table compares Value averaging and Dollar cost averaging: