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!
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.
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|
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.
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?