Dollar Cost Averaging (DCA) vs Dollar Value Averaging (DVA)
When investing in stocks, bonds, mutual funds or ETFs, the term “dollar cost averaging” is usually mentioned as the no-frills approach to investing. This post will compare dollar cost averaging to dollar value averaging and discuss their pros and cons.
DCA is a relatively simple and practical approach to investing, where we invest a small amount of money each week (if mutual funds, since they carry no trading commissions), month or quarter (if stocks, bonds or ETFs). This ensures that the buy price is averaged out since the periodic amount is set, no matter Mr. Market’s whims.
Say, if an investor were to buy $500 worth of mutual funds (I’m using them for convenience since trading commissions are avoided) each month, then they would buy more units when the price is low (@ $10 per unit, one would get 50 units for that month) and lesser units when the price is higher (@ $25 per unit, one would get 20 units for that month). So, after two months, the investor would own 70 units with an adjusted cost base of $14.28 per unit. This method, essentially, takes emotion (panic, greed and the like) out of the equation as long as the investor sticks to his investment policy, which would be to invest $500 at periodic intervals (every month in this case) through thick and thin.
Dollar Value Averaging (DVA)
DCA is a good method for many investors who do not have the time and/or interest and/or skill to control their investments. For those that do, DVA may be worth looking at.
DVA involves setting a target rate of return for the overall portfolio. In other words, DVA requires the investor to specify an expected (preferably real) rate of return, be it 3%, 4%, or 5%, for the whole portfolio. As an example, assume that an investor has an expected real rate of return of 5%. Say, he contributes $2500 for the first quarter and buys shares in ABC, DEF, and ZYX Corporations (I’m leaving out the trading commissions for ease but they should be included when calculating for a real portfolio).
After the first quarter, the value of the total stock portfolio goes up to $2700. But, based on the investor’s target growth rate, the portfolio should have been $2625 (i.e., 2500*1.05). So, the investor would only contribute $2425 [calculated as (2500*1.05+2500)-2700] for the second quarter to bring the portfolio value to its target (he could split the $2425 among the 3 stocks based on his planned sector-wise allocation or buy new stocks).
Instead, if the investor was dealing with a big windfall of $100,000 that he did not plan to add to, then based on the above example’s rate, he should have $105,000 (100,000*1.05) after one year. But, if his portfolio returned 10% after a year through a market upswing, then he would withdraw $5000 [(100,000*1.1)-(105,000)] to bring the portfolio to its 5% target return (which stock should be sold if there are multiple winners requires due diligence).
This process will continue every year, i.e., the total portfolio value should be $110,250 (105,000*1.05) after the second year; the investor would have to add or withdraw cash based on the actual portfolio value. This method ensures that the investor will buy (invest) less when the share price is higher (since the portfolio value will be higher than expected, he needs to contribute less for the next period) and more when the share price is lower.
Is one better than the other?
Pros and Cons of DCA
- DCA makes the investor buy shares or units for the same set amount of contribution at periodic intervals. This cycle would repeat on an automatic basis irrespective of market movements, thereby eliminating investor interference.
- But, this lack of investor input also means lack of control, i.e., the contribution remains the same even in an overvalued market.
Pros and Cons of DVA
- DVA makes the holder invest lesser amounts when the prices rise and higher amounts when the prices drop, thereby providing better value (no pun intended).
- DVA does this by defining an expected rate of return, which should be realistic, and works to keep the portfolio on track. Thus, the value-averaging investor has a target in mind and stays aware of his progress or regress. The final return will not be higher than the expectation, since the investor may buy less or even sell at times of a market upswing.
- DVA requires active investor participation but may offer enhanced rewards. Evidently, such an active role means that the investor needs to spend more time than DCA.
- Nonetheless, the major drawback is that in a severe market downturn à la 2008, it would take significant contributions to get the portfolio on track – money that many investors may not have!
The bottom line is that DCA and DVA are two different methods to invest – each with their own limitations. The unifying factor is that both promote saving money, which is the fundamental building block for a successful future.
Do you use one of these methods for investing? Are there other points worth remembering about either? Has someone tried both?
About the Author: Clark works in Saskatchewan and has been working to build his (DIY) investment portfolio, structured for an early retirement. He loves reading (and using the lessons learned) about personal finance, technology and minimalism. You can read his other articles here.
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I just finished reading Bernstein’s book The Intelligent Asset Allocator and it is excellent. It is just under 200 pages and he takes you by the hand and shows you what works and what doesn’t in investing. Toward the end he introduces Value Averaging and gives an example of how it would work and why it is better than DCA. He refers you to Edleson’s book Value Averaging: The Safe and Easy Strategy for Higher Investment Returns for a much deeper review of DVA versus DCA. He then uses long term historical data to compare the two. In the “short” term they produce similar returns, but as time goes on they both start to gradually fade a little compared to the long term “growth of the overall market” (USA). To deal with this situation he uses a Growth-Adjusted Formula for DCA and a Growth-Adjusted Formula for DVA and compares the results. WOW, he finds DVA has outperformed DCA from 1926 to 1991 by 1.46% (ie. 11.46% versus 12.56%). To use DVA properly you will need to know or learn MS Excel (or Lotus 1 2 3) so you can enter the various “inputs” per his DVA formula. If one had say 4 to 8 index funds or ETFs I would think you’d have an Excel spreadsheet set up for each. Both authors highly recommend using Vanguard.com (USA) index funds and/or ETFs due to both their very low expense ratio AND very low turnover percentage. Re cash on the sidelines in a low return money mkt fund: because you have wisely set aside this cash you will be handsomely rewarded in the future since it buys shares at bargain share prices in a market downturn. Thus buy as much as you can comfortably afford with this cash but don’t mortgage the house. Note that the best Value mutual funds generally will sell off stocks when the market/s are expensive and hold rather large cash proceeds for when stocks are very low. Both books are available on Amazon as well as Excel for Dummies. July 11, 2019
I use a DBA method (Dollar “Blended” Averaging) with portions of both DCA and DVA. Here’s how I implement it.
I have fixed percentage for each equity in my portfolio. I regularly put the same amount of money in my portfolio to do DCA, but instead of equally dividing the money to all stocks, I put all of that month’s contribution into a stock that’s under-performing (or lagging behind than the others). Thus, a better performing stock that’s over-shooting the designated percentage will not get anything, while an under-performing stock will result in me buying more shares of it.
If you have a solid dividend achiever’s portfolio and your stocks have an unparalleled history of increasing the dividends, with a decent dividend growth ratio, then this strategy works like a charm.
I, too, had not heard of DVA. Interesting idea. It certainly would need more effort but, more importantly, a contrarian philosophy that most people would find extremely uncomfortable.
“Invest MORE when the market is DOWN? And stop investing when everyone is buying and the market is shooting through the roof?!?!”
I wonder if there are any financial planners which manage this method for their clients.
DVA is a form of market timing asset allocation. I think it can be assumed the appropriate place to keep the cash would be in a money market fund where it would draw a little interest.
Any investment program that has you selling off winning stocks keeps you from benefiting from their future price rises, and forces you to pay capital gains taxes and extra commissions.
And that’s not even addressing the issue of what gain you should “target.” Most people are going to say, “I want as much as I can get” — and they’re right.
In other words, DVA makes no sense.
I don’t like mutual funds, though. They have expenses of their own. I prefer Exchange Traded Funds.
So why make it complicated?
Investors should put as much money as they can afford out of their paychecks and into a money market account. When they have enough, buy 100 shares of an income-oriented ETF. Reinvest the income.
Keep that up until you retire.
However I haven’t yet invented any fancy names for that.
@RuralDoc,
Thanks for that spreadsheet link; I have something to play with now!
Hi All,
I’ve been using DVA for some time and find it to be a very effective strategy. It does require one to place a “realistic” rate of return and have access to what can amount to a significant amount of cash to add to the value path during market downturns.
For example, if you expect your portfolio of 60%Equities:40%Fixed income to grow from 100,000 to 105,000 and it it suffers a 25% setback. You will need to have 30,000 to add in order to keep to on track.
The flip side is that should your portfolio return 20% you would take the excess 15,000 and keep it in a high interest account to contribute in the future.
The biggest challenge is to keep the side account at 25% + expected return.
There is a great spread sheet available at http://ca.wiley.com/WileyCDA/WileyTitle/productCd-0470049774,descCd-DOWNLOAD.html
Play with the numbers.
While I use a basket of ETFs and contribute quarterly, I think that you could easily use the ING street wise funds of another balanced fund and do the same thing.
Cheers
I use DCA in a Seg fund. It was my first investment, and so easy to setup. I was able to start with $25/month, which purchased about 1 share each month.
As the share price rises, I increase my contributions and frequencies.
I think its best to make sure you are purchasing at least 1 share each purchase, and best case scenario would be once a week. I found that by just doing the ‘pac’ on a once-a-month basis, I was missing a lot of buying opportunities.
DVA sounds interesting, maybe I will use it for my non-reg online broker account in the future. But for now, savings up enough ($500) for each purchase, and waiting for the stock I want to purchase to reach the low I need, seems best for me.
Nice post comparing the 2, I love learning more ways to invest! Thanksss
Good post. DVA merely triggers allocations based on valuations and yes $ is often left “on the sidelines” in secular bull markets: cash (do nothing) is sometimes a valid decision for some or all of a contribution with DVA.
You should put some meat on the bones: since DVA decisions vary with time, what would be the recommended actions in the current environment? DCA is easy-peasy by comparison.
To wit a commenter stated: “Money flows naturally into equities during downturns and into cash/bonds during bull markets.” Ah but is this not a “bull” market? Should I be buying bonds now?!?
Clark, thanks for sharing on DVA. The DVA method would fit in well with someone that is doing a couch potato portfolio type of thing.
I’ll personally be sticking with the DCA for retirement account though if only for the simplicity it provides.
I agree! Both methods are good because as long as the investor is using them, it means that he or she is saving money! Something that many Americans have a hard time doing. One way to overcome the lackings of dollar cost averaging is to simply rebalance your asset allocation so that you buy more shares of fixed income securities when the equity markets are rising.