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Saturday, July 12, 2008

Review: Value Averaging

Value Averaging (Kindle Edition) comes highly recommended by none other than William Bernstein, the master of asset allocation himself.

This short book is incredibly dense reading. The concept of value averaging itself is simple: rather than buying a constant dollar amount of shares on a regular basis (dollar-cost averaging), what you do is to chart out a projected progression of your portfolio over time, and on a regular basis, add money or sell shares to match the charted progression. The result is a disciplined buying strategy that buys more stocks when the price is low, and sells them when the price is high.

If that was all, you wouldn't be paying even the Kindle-discounted $10 to buy this book. There are several complications. First of all, over time, your portfolio should grow --- if all you're doing is saving a fixed amount of money over each interval, then the adjustments you can make with that fixed sum eventually gets swamped by the portfolio growth itself. So you'll have to also adjust your savings by the projected growth (unfortunately, if your income doesn't grow as your portfolio grows, you might be in a bit of a bind in this regards).

Secondly, there are tax implications --- the required selling in a taxable account might trigger capital gains which reduce the efficacy of this approach. Depending on the current capital gains rate, this could complicate implementation.

Finally, if you are saving (and investing) for a particular goal, you might need to adjust your savings rate as the market movements move you closer or further away from your goal --- at the very least in the last few years of your goal you might wish to go to more bonds to reduce the risk of a sudden market collapse preventing you from achieving your goals.

To its credit, the book covers all these details and more. Just as importantly, it provides the spreadsheets by which you can do your computation online for easy downoad.

There are a few problems that I can see with this approach: first of all, this sort of formula investing requires you to provide (in the spreadsheet, if not elsewhere) a projected investment return over the period of savings --- being off in that adjustment can result in dramatic under-saving. Secondly, for someone who's building a portfolio and have no idea of what their future income will be (most people fall into this category), I don't see how this kind of planning can be achieved.

Finally, once you get to your goal (say, your magic number for retirement), there's no guidance as to what you should do now. (Note that there are other resources that help you with this, so that's less of a problem with this book)

People who should read this book:
  • Fresh graduates and people building portfolios over a long period for a specific goal, if they can articulate such goals (college savings, etc)
  • Those with relatively stable income who have their act together enough to be able to work on these spreadsheets
  • Those with a lump-sum investment who find themselves paralyzed because they fear buying into a market at a peak (there's been a number of my colleagues who've fallen into this category --- I recommend this book to them)
This book, however, does not help with:
  • Setting a portfolio allocation
  • Deciding what appropriate goals should be
  • Keeping you disciplined enough to take the buy low/sell high approach that value averaging will naturally ask you to do.
All in all, I liked this book --- the approach and comprehensiveness is welcome. However, it's of limited applicability for me and my portfolio, and I suspect that implementation will be more complex and harder to do than a casual reading of this book might lead you to believe. Recommended as fruit for thought.

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