Dollar Value Averaging – Where have you been all my life?

Last weekend, I was out playing some racquetball with Freedom Thirty Five Blog and Modest Money. Jeremy has been raving about Jason Kelly’s book, The Neatest Little Guide to Stock Market Investing, for a few months now (check out his review). He brought me a copy to read, and in record pace (for me, at least) I’ve managed to read almost the entire book in a single week. It helped that I was visiting my family and had lots of down time!

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How to pick stocks

Overall, the book does a really good job of focusing on key aspects of a company that you should be researching and explaining why these are key indicators of a potentially good stock pick. As someone who has been investing in stocks for a number of years, this book was a really good refresher. There is so much information out there, it’s hard to know what’s relevant and what is not. It pains me to say, that most of my stock picks to date have been based on positive reviews and a decent opinion of the company. Thankfully, so far my individual stock picks (Shaw Communications – SJR-B.TO and Husky Energy – HSE.TO) seem to be solid picks as I go back and employ Kelly’s methodology.

Dollar Value Averaging

However, in my opinion the best advice comes when Kelly discusses Dollar Value Averaging (VA). He covers this topic as part of his chapter on ‘permanent portfolios’. The idea is that you have a base portfolio make up of indexes, ETF’s or mutual funds which form the core of your investment portfolio. Individual stocks make up a  smaller portion but are key to maximizing your returns. In a book focused on helping research and pick individual stocks, Dollar Value Averaging works best on ETF’s, indexes and mutual funds – your core portfolio.

By investing money in the market at regular intervals, market variability is lessened. The simplest way to invest periodically is through Dollar Cost Averaging (DCA). This is what I do currently and what I’ve always done. Each month, I transfer money into my brokerage account and buy whichever ETF is cheapest or brings my desired allocation back into line. However, this also means that I am buying the same amount of ETF whether the market is high or low. As Kelly points out “if buying more shares when they’re cheap is a good idea, then isn’t it an even better idea to send extra money when the price is cheap and less when it’s expensive?”

Where DCA puts the same amount of money in no matter the price, VA sets a target growth rate and buys or sells shares to meet this growth rate. Kelly used the target growth rate of 3% per quarter, or 12.6% annually. To illustrate how VA works, I’ve provided a hypothetical example with my stock in Vanguard’s FTSE Canada ETF (VCE.TO). I started with 200 shares this summer and the rest of the table are hypothetical prices of the ETF over the next year and a half, to illustrate the point. Kelly also provides some examples on his website.

CORE 1 VCE.TO (Vanguard FTSE Canada ETF)            
Quarter Ending Price Shares Held Current Value Shares to buy (-sell) for 3% growth Cash Flow New Cash balance New VCE.TO balance
June 2013 $26.02 0 $0.00 200 -$5,204.00 $0.00 $5,204.00
Sept 2013 $26.50 200 $5,300.00 2 -$60.12 $0.00 $5,360.12
Dec 2013 $25.00 202 $5,056.72 19 -$464.21 $0.00 $5,520.92
Mar 2014 $28.25 221 $6,238.64 -20 $552.09 $552.09 $5,686.55
June 2014 $31.50 201 $6,340.76 -15 $483.61 $1,035.70 $5,857.15
Sept 2014 $30.00 186 $5,578.24 15 -$454.63 $581.07 $6,032.86
Dec 2014 $33.00 201 $6,636.15 -13 $422.30 $1,003.37 $6,213.85

What I like about VA is that you take money back off the table when the price is high (over your target growth rate). This is especially neat when the fund becomes almost self sustaining. You can see that after March 2014, I wouldn’t have had to put any money back in – the cash would already be sitting there from shares I’d sold when the price was higher.

What ETFs or funds to use with Value Averaging

Obviously you will need to use a fund or ETF which has the potential volatility to meet your target growth rate. A bond fund likely won’t ever return 3% a quarter, meaning you’ll just be putting money into the fund, which is the same as saving money. Any fund or ETF that tracks large markets should have enough volatility to do it. Kelly uses the iShares S&P Small-Cap 600 ETF (IJR) in his example. I’ve chosen to run three in parallel – Vanguard’s FTSE Canada ETF, Vanguard US Total Market CAD ETF (VUS.TO) and iShares MSCI EAFE ETF (XEF.TO), all with a target 3% per quarter. I’ve also got money in the BMO Aggregate Bond Fund (ZAG.TO) to supplement the 3% growth if required.

I’m just starting out with Value Averaging, but things look promising! What methods to you use to invest periodically? What do you think about my plan to use value averaging?

 

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12 Comments

  1. We follow a Value Averaging investment plan as well. As risk averse people we like that it forces us to sell during market peaks (when growth of market is above tgt growth rate) and forces us to buy during market dips (when growth of market is below tgt growth rate). We keep money in bonds/cash to balance those purchases/sales. The simplicity of the plan is a huge benefit, it prevents you from freaking out during market drops or getting greedy during large market run ups.

    • Brian says:

      I really like that when the market goes up, I realize the gains. It’s not just there on paper, but cold hard cash! We’ll see how I feel when the market is down…

  2. Liquid says:

    Hey you’re getting through that book pretty fast :) Value averaging is a great strategy because it essentially lets you control the portfolio growth. I haven’t implemented this myself yet because my savings rate isn’t steady enough throughout the year in case a major correction happens. But I also like the book’s other strategy called Double the Dow :D Nice job on the html table, btw 8-) And thanks for the mention.

    • Brian says:

      Like I said, I had a lot of time on my hands. Having fun researching actual stocks now and sort of understanding what I’m doing.

      I chose ETF Value Averaging over double the Dow because I wanted to keep my RRSP portfolio in Canadian or Canadian hedged investments. I will be adding some individual US stocks to my RRSP portfolio due to the dividend tax treatment, but staying with the canadian ETF’s for now.

  3. I used to have a few indexes that I would add up to every month, investing can’t be simpler if you do that, and you don’t have to watch your stocks until you need the money, making it real passive and with that you avoid emotional decisions as well.

  4. Clifford Phillips says:

    Robert Lichello wrote a book SuperPower Investing, he describes A plan called Synchrovest. I think it can give Value Averaging a run for its money.

  5. Kevin says:

    Great article! I’m thinking about trying this soon.

    In both your example and Jason Kelly’s you both conduct a trade every three months to achieve a 3% per quarter growth rate. What are your thoughts on trading every month to achieve a 1% per month growth rate? Or even a trading every week to achieve a .25% per week growth rate? The only things I can think of that make this impractical are mutual fund trading minimums and transaction fees.

    I think trading at a higher frequency like will further minimize market variability. But being a young investor, I feel that I should be taking on more risk, so more frequent trading may also reduce potential gains due to these variations. Quarterly trading may be the ideal.

    What are your thoughts?

    • Brian says:

      Hi Kevin, thanks for stopping by! I chose quarterly so as to limit the work required to manage the portfolio. I’m trading EFTs and my brokerage lets me buy and sell them with no fees, so theoretically I could choose a more frequent trade rate. Trading every three months actually limits volatility because you’re only reacting to the major trends in the market. If you trade more often, you are reacting to the emotion of the week, rather than the long term trends based on underlying fundamentals, so for that reason I wouldn’t trade any more frequently than once a month.

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