Value Averaging A Smarter Way To Invest
Value Averaging A Smarter Way To Invest
Value Averaging A Smarter Way To Invest
2.
It takes some of the emotion out of the investment timing process (you invest every month, regardless of whether you
think the share market is over or undervalued).
Value Averaging is similar to Dollar Cost Averaging, except it takes the process one step further. With Value Averaging, you still
make regular monthly investments, but this time a decision is made to invest each contribution into either Cash or Shares.
So how do you decide? Well its all about Fair Value. As I mentioned earlier the Australian share market has made an average
return of 11% a year in the 30 years leading up to 2010. So lets be a bit conservative and assume that a fair rate of return (in
exchange for the amount of risk we are going to take) is 9% a year. If we have an investment time horizon of 30 years (maybe this
is when we plan to retire), then this allows us to create a Fair Value line. Lets assume you have the following investments and
savings in place and take a look at what the Fair Value line might look like:
Investments
Contributions
9% a year
Time horizon
30 years
$16,000,000
$14,000,000
$12,000,000
$10,000,000
$8,000,000
$6,000,000
$14,107,640 is
your "Fair Value"
Investment Goal
after 30 years
$4,000,000
$2,000,000
$0
Nov-80
Nov-85
Nov-90
Nov-95
Nov-00
Nov-05
Nov-10
Palmer Portfolios Pty Ltd (ABN 41 533 933 417) is a Corporate Authorised Representative (no. 301761) of Palmer Portfolios Group Pty Ltd AFSL: 376719 ABN: 78 145 431 107
Instead of investing ALL of your initial starting amount into shares, you start with 15% in Cash
When the value of your investments trades above this Fair Value line (due to normal market fluctuations) you sell down
your shares (i.e. increase Cash) to put aside for a rainy day when shares are selling cheap.
$20,000,000
$18,000,000
$16,000,000
$14,000,000
$12,000,000
$10,000,000
Cash
$8,000,000
$6,000,000
$4,000,000
$2,000,000
"Fair Value"
Investment Line
$0
When the share market is doing well (like in the years leading up to the 1987 and 2008 crashes), your portfolio is slowly
accumulating cash. This is because the annual return on your investments is above your target return of 9% a year. So
under the Value Averaging strategy this cash is tucked away to use when the market falls below your 9% Fair Value
line, and shares are arguably cheap.
2.
The Value Averaging strategy has produced a higher internal rate of return over the 30-year time period, and by allocating
part of the portfolio to Cash it has experienced less volatility.
Palmer Portfolios Pty Ltd (ABN 41 533 933 417) is a Corporate Authorised Representative (no. 301761) of Palmer Portfolios Group Pty Ltd AFSL: 376719 ABN: 78 145 431 107
Value Averaging automates the buy low & sell high process and takes the emotion out of market timing decisions.
Helps clients visualise and stick to a long-term investment strategy, and to understand that market falls (and rises) are a
normal part of the investment cycle. Indeed, market falls now become an opportunity.
Having an automated strategy will stop most investors from making poor market timing decisions (i.e. panic selling when the
market falls, or buying more investments after an extended period of above-average returns).
By increasing your allowable cash weighting later in life, Value Averaging can help you to reduce your overall risk profile as
you approach retirement.
How often is cash adjusted?
In the example above we have assumed monthly contributions to the planned portfolio. However, the regular cash adjustment (the
decision whether to buy shares, or increase a clients Cash Weighting) does not need to be done monthly. In fact, when you take into
account transaction costs, it has been shown that adjusting the strategy quarterly produces the same long-term benefit, but with less
ongoing cost.
What about the underlying investments?
Value Averaging does not replace good investment selection. In the long-run, a portfolio will benefit from having exposure to a good mix
of growth and income producing investments. With the Value Averaging strategy, your portfolio will usually be split into two components:
1. Growth component. This will typically hold a diversified blend of both Australian and International shares, or share funds, and
will nearly always account for the majority of assets in the portfolio, according to your agreed Risk Profile.
2. Cash component. This can be invested in term deposits, fixed interest funds or at-call cash within the portfolio. The cash
component is also invested to maximise the return while sitting idle.
The majority of long-term returns will be from the Growth component. However, for those times when you are holding extra cash (waiting
for the market to correct) its important to ensure the cash is generating the best return possible.
But what if I am retired or approaching retirement?
Value Averaging is not reliant on the client contributing funds to the portfolio. Even if you are regularly withdrawing (i.e. to fund your
retirement lifestyle) you can use Value Averaging to construct a Fair Value investment line.
If you are retired or approaching retirement, it may be that you adopt a more conservative approach to Value Averaging. This can be
done by increasing your initial Cash Weighting (from say 15% to 40%), or by lowering your Target Return from say 9% to 6%. By
lowering your target return it is likely you will store more of your portfolio as cash in the years ahead, thereby reducing your Risk
Exposure later in life.
Palmer Portfolios Pty Ltd (ABN 41 533 933 417) is a Corporate Authorised Representative (no. 301761) of Palmer Portfolios Group Pty Ltd AFSL: 376719 ABN: 78 145 431 107
Palmer Portfolios is a fully licenced financial advising firm, and one of the few in Queensland to operate a Limited Managed
Discretionary Account service. Called our Optimum Portfolio Service, it is an agreement between us and our clients to
manage both the underlying investments in our clients portfolios and the regular Cash Adjustments necessary for the Value
Averaging strategy (within agreed parameters).
To our knowledge, we are the only financial advising firm in Queensland offering Value Averaging as a long-term investment
strategy. It is a complete service encompassing a full Financial Plan and initial setup of a clients Fair Value Investment line,
the ongoing management of investments and cash adjustments in the portfolio, and quarterly reporting of your progress
towards your goal.
What else you need to know
More information on Value Averaging can be found online and also in the book Value Averaging: The Safe and Easy Strategy
for Higher Investment Returns. A free copy of which is available to any client who wishes to research this strategy further.
There is also a good summary of Value Averaging on the Wikipedia website, with links to further
reading http://en.wikipedia.org/wiki/Value_averaging
While Value Averaging has been shown to increase the internal rate of return (IRR) in a wide range of different market
conditions, there are no guarantees that this will be the case in the future. Having an allocation to cash will reduce the overall
volatility of your portfolio, but can lead to a lower overall return in times of exceptionally good market returns.
There can be capital gains tax (CGT) implications of selling investments in a rising market. While we always look to minimise
CGT, it is possible that CGT could be higher under this strategy. However, we believe this is offset by the reduced volatility and
likely higher returns of the Value Averaging strategy.
If you would like more information on the Value Averaging Strategy, I invite you to contact me personally.
Palmer Portfolios Pty Ltd (ABN 41 533 933 417) is a Corporate Authorised Representative (no. 301761) of Palmer Portfolios Group Pty Ltd AFSL: 376719 ABN: 78 145 431 107