Value Averaging Definition

Value averaging is an investment technique that seeks to ensure some future value by altering the periodic contribution of new funds in accordance with the market value fluctuation of the investment account. Thus, when the market is performing well new contributions are limited while when the market is performing poorly new contributions are high. Note that this in effect implements the age-old adage of "buy low"-when the market is down new cash flows into the account; when the market is high new cash does not flow into the account.

For example, say that an account has $10,000 and the account holder’s goal is to add $500 worth of value every month during the year. At the end of the first month, the account value is $10,480-the account holder thus contributes $20 to bring the account to the planned $10,500. At the end of the second month, the account value is $10,470 (a slight decrease)-the account holder thus contributes $530 to bring the account to the planned $11,000. At the end of the third month, the account value is $11,530 (a big increase)-the account holder does not contribute anything because the actual value exceeds the planned value. This process repeats until the end of the year and, as planned, the account value stands at $16,000 (the original $10,000 plus a $500 per month gain). Of course, value averaging assumes the account holder has cash to "make up" for market downtrends, which may not be reasonable.