What is Value Averaging?

Value averaging is a strategy in which an investor places a variable dollar amount into a given investment (usually common stock) on a regular basis to ensure that the investment grows by a certain dollar amount or percentage over time.

The investment generally takes place each and every month regardless of what is occurring in the financial markets.

How Does Value Averaging Work?

Let's assume John Doe has $5,000 in his new-car account. He wants that to grow to $10,000 by the end of next year. Accordingly, he needs the account to grow by $416 a month.

If John uses a value averaging approach, he would invest the $5,000 in, say, the ABC mutual fund at the beginning of the year. If at the end of month one the fund has earned, say, $100, then John contributes only $316 that month. At the end of the second month, if the fund has earned only $50, then John contributes $366 that month. If in the third month the fund loses him $75, then John contributes $491. In this way, John ensures that the account balance equals $10,000 at the end of the year.

Why Does Value Averaging Matter?

Value averaging is useful for people who contribute to their investments on a regular basis, and it helps eliminate the temptation to try to time the market. Additionally, it provides some peace of mind that the investor will indeed have the desired amount at the end of the investment period.

Note that in our example, however, as the account balance grows, it may become harder for John to fund any monthly shortfalls in the account. Accordingly, if shortfalls are becoming an issue, John may need to rebalance the account to add higher-performing assets.