Archive for September, 2008

What’s Value Cost Average Investing?

Value cost averaging is a strategy for spending more money to buy stock when the price is low and less money when the price is high. It is similar to dollar cost averaging, though it can be more effective and it requires more of an active role for the investor.

Dollar cost averaging is a safe investment strategy, any financial expert or experienced investor can tell you that. But the caveat for this type of investment strategy is that you are sacrificing maximum profit potential in exchange for simplicity, automation and less of an active role by you as the investor.

The beauty in this market is that you will buy at lows and ride the wave higher.   The strategy is great for people with the proper duration needed for their investments.

Looking for a strategy with these kinds of conditions may seem like a pipe dream but a strategy does exist that maintains the disciplined approach of dollar cost averaging and yet is flexible enough to keep your investments low during times when the market is high and increase your investment when prices fall down.

It is called value-cost averaging or VCA. VCA takes the concept of dollar cost averaging a step further by varying the amount of invested money based on the price fluctuation of the fund (rather than investing a fixed amount at fixed intervals). This investment system is quite simple although it requires a bit more work than dollar-cost averaging.

In order to make the value cost averaging system work, the first thing you should do is NOT to second guess the market. You must be able to invest on a regular basis without fail. If you decide that you want to take advantage of the system by waiting out for the market’s prices to go down, then you effectively become a market timer. But no one can time the market: so value cost averaging falls somewhere between dollar cost averaging and market timing.

Here is how value cost averaging investing works:

You must first determine how much money you would like to put into a mutual fund and at what interval you want to invest your money (it could be bimonthly, monthly, or weekly). Sounds like dollar cost averaging, right?

Here the two systems diverge. Take note of the date and the price you paid per share. For example, you invested $100 at $12.50 per share. When it is time for the next investment you either call the fund or check the price in the papers. Write the date and the price down and do a simple calculation to determine the percentage difference between the two price references. Using the example, let’s say that the fund rose 50 cents to $13 a share. If you divide .5o by 12.50 you will see that the fund has increased 4 per cent. Knowing that, make a check out to the fund for $96 or 4 per cent less than your initial investment. Don’t forget to adjust your baseline price for your $100 investment to $13 a share. Not adjusting the baseline would mean that, if your fund kept increasing value, then you would eventually have nothing to add.

Based on the computation, it should be obvious that if the share price declines, you will add more to your base investment.

Be forewarned: if you endeavor to do value cost averaging, most mutual fund companies do not provide an automated system. One of the most important keys to building wealth is systematic investing and if you can’t discipline yourself to actively invest on a consistent basis, then dollar cost averaging may be the better strategy for you.

This will beat the market for the money that is invested and keep liquidity for you other funds in your money market.   This is the best strategy to re-enter the market, for those of you sitting on the sideline.   If you think the economy may take 12 months or even if you take 36 months, figure out how you can enter the market at a reasonable rate, adding dollars each period and by the end of the 36 months, if the market still is going to go down, you will profit more.   

See, the Vanguard Group for more information.   This is the smartest bet for re-entering the market.

Here is a brilliant trader magazine, thinkMoney #4.   I love ThinkorSwim!!!   These guys understand two things, trading and technology.    They really have created a revolution. Past thinkMoney issues: thinkMoney #3 thinkMoney #2 thinkMoney #1