What is Value Averaging (VA)?

Key Highlights

• In value averaging, investments are adjusted based on market value and a predetermined growth path.
• This strategy aims to maintain consistent portfolio growth by acquiring more shares at low prices and fewer at high prices.
• Value averaging investment plan in India may offer potential long-term returns, including disciplined investing.

Understanding Value Averaging Investment Plan

In value averaging, you invest an amount in accordance with your investment objectives. Instead of investing a fixed amount every month, you invest based on how close you are to your goal.

When using an averaging strategy, investors first determine which value path they need to follow based on their target investment goal. A value path indicates how much growth you need to achieve over a period of time in order to reach your larger investment objective.

According to your preferences, you can break this down monthly, quarterly, or annually. The value path can be defined in terms of the amount or percentage of growth. So, for example, depending on your goal, you might need to grow your portfolio by 6% or INR 100,000 every year. As your value path progresses, you adjust your monthly investment contributions.

Value Averaging Example

For a better understanding of VA meaning, let's take a hypothetical example. An investor has decided to invest in XYZ stock for an extended period of time in order to build wealth. This year, he has 1200 rupees to invest. So, rather than investing 100 rupees every month, he waits for a stock decline and then invests heavily.

Advantages of Value Averaging

In this section, let’s explore the potential benefits of VA:

1. Systematic Investment Approach Investing in averaging allows investors to achieve their financial goals in a disciplined manner. In this approach, investors regularly invest the amount of money to achieve their portfolio value. Investing in this systematic manner allows investors to avoid impulsive decisions that might lead to losses.

2. Lower Portfolio Volatility An averaging strategy can reduce portfolio volatility. In a low-priced market, investors buy more shares and buy fewer shares in a high-priced market, so the overall cost per share is lower than the average. In this way, an investor's portfolio is less likely to be adversely affected by market fluctuations.

3. Enhanced Long-Term Performance Investing in value averaging over time can maximise returns over the long term. Since the strategy encourages investors to buy more shares when prices are low, the portfolio will benefit from any potential market upswing. This can lead to enhanced long-term performance and higher returns over time.

Disadvantages of Value Averaging

While Averaging may have some benefits, it also has some drawbacks.

1. Complexity in Implementation Regularly monitoring the market and adjusting investments are essential to averaging. In addition to being time-consuming, it may require an understanding of investment principles.

To implement this strategy effectively, investors may also need specialised software or a financial advisor.

2. Potential for Larger Cash Outlays It is also possible for value averaging to require large cash outlays during periods when asset prices are declining. When prices are low, investors may need to invest more money to maintain the target growth rate.

For investors with limited cash reserves or who are uncomfortable with the added risk, this increased investment during market downturns can be challenging.

3. Inflexible Investment Schedule Value averaging requires investors to invest a fixed amount of money on a regular basis, which can be inflexible. Some investors may not be able to commit to a regular investment schedule due to fluctuating income.

In addition, this strategy may not be suitable for investors who need liquidity on a short-term basis or need quick access to their assets.

Dollar-Cost Averaging vs Value Averaging

There is often confusion between dollar-cost averaging and value averaging. To understand the VA concept better, here is a comparison of Dollar-Cost Averaging vs Value Averaging.

Dollar-cost averaging and value averaging both aim to promote consistent investing habits, but they work differently. A value averaging strategy guides your monthly contributions based on your portfolio's value and investment goals. In contrast, dollar-cost averaging involves investing a fixed amount each month, regardless of the value of your portfolio.

In order to navigate market fluctuations, dollar-cost averaging is used. Investing when the market is down allows you to buy more for less, while investing when the market is up allows you to purchase fewer shares as the price rises. Dollar-cost averaging is easier for those who prefer a hands-off approach. A fixed amount can be set up for automatic monthly investments in your account.

When it comes to returns, factors such as consistency, investment choices, time frame, and market performance all play a role. Each strategy can be beneficial, depending on your circumstances.

Conclusion

As a disciplined investment strategy, value averaging can offer a range of advantages, including greater long-term returns and a systematic approach. However, this method does have some drawbacks, such as its complexity and the possibility of higher cash outlays during market downturns. To determine whether value averaging is suitable for investors, they need to analyse investment goals, risks, potential benefits, and downsides of investment.