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Value Cost Averaging?
Old 02-22-2013, 11:32 AM   #1
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Value Cost Averaging?

I am still in the accumulation phase- (for about 8 more months) and am new to the VCA method and not sure I completely get it...
I have been putting money in every 3 months to be distributed according to keeping my asset allocation at appropriate levels. This is the first time that my portofolio is up so much that I am not sure that I am interpreting the VCA strategy correctly and am looking for a little guidance.

As I understand it--you pick a target return you expect to hit--for me maybe I set it too low..at 6% or 1.5% per quarter. If the value of my portfolio falls short, I put in enough to get it back to where it should be and then my usual quarterly input as well. BUT if it is up, I take out from what I would usually put in....well this quarter my portfolio is more than double ahead--that is it is up by the amount I would add 2 x over...that would suggest putting nothing in? Or taking some out?
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Old 02-22-2013, 01:54 PM   #2
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Are you using Edelson's book? IIRC, it does a good job of spelling things out.

I'm not an expert in VCA. The approach has a good record of helping investors buy assets at lower overall costs. If you want to use VCA, I'd argue that you should not stop or slow your savings for retirement if your assets are growing faster than anticipated--you should at least put the "normal" monthly contribution in a safe, stable spot (MM fund, ST bond fund, etc) so it will be available for later use when values are more favorable.

But it does smack of market timing, and I'd personally prefer to forgo the hassles of setting (arbitrary) growth lines and instead just put the new monthly investments into whatever sector of my AA was low. There will always be something that is lagging, and when the market does take off your money won't be sitting in a MM account.
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Old 02-22-2013, 03:57 PM   #3
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Originally Posted by urn2bfree View Post
I am still in the accumulation phase- (for about 8 more months) and am new to the VCA method and not sure I completely get it...

As I understand it--you pick a target return you expect to hit--for me maybe I set it too low..at 6% or 1.5% per quarter. If the value of my portfolio falls short, I put in enough to get it back to where it should be and then my usual quarterly input as well. BUT if it is up, I take out from what I would usually put in....well this quarter my portfolio is more than double ahead--that is it is up by the amount I would add 2 x over...that would suggest putting nothing in? Or taking some out?
I recently used a VCA spreadsheet that I built to allocate a fixed sum of money into a new account. As you allude to the big question is in setting up a reasonable return rate.

IMO you do NOT want to be taking money out of your account. If the market is up you just hold the investment to the next period. I did my investments on a weekly period so there was a better chance I could hit the low points and get money put to work. In the final analysis, whether you come out ahead on this is much the same as using DCA - you are at the mercy of the market and the direction it is going.

After testing out the VCA method for persons just wanting to invest 10%-15% of their paycheck, I recommend you just use the DCA method.

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Old 02-22-2013, 04:07 PM   #4
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It pretty easy. Let's say you have $120,000 to invest and you want to put it into play over 12 months beginning in January, or a baseline of $10,000 a month.

On January 2, you invest $10,000. On February 1, you look at your balance and it is $9,800 - you then invest $10,200 to bring the balance to $20,000. On March 1, the balance is $20,500, so you invest $9,500. Repeat each month until the entire $120,000 is invested.

Note that in February you invested more when the investment was relatively lower and in March you invested less when the market was relatively higher.

If you want to get fancy you could increase the monthly amount a bit to reflect the fact that on average you expect the investment to increase in value (say to $10,500 increase each month rather than $10,000) but IMO there is no need to bother with that, it is just that you may need 13 months to fully invest the $120,000.

If you're doing it from cash flow it would work the same - you would have a target amount to invest each month and the actual amount invested may be higher or lower.
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Old 02-22-2013, 04:20 PM   #5
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As mentioned it works better if you are putting a fixed amount into a new account, like I was doing. It does not work as well for a person accumulating new money every month -- unless of course you consider the new money invested by itself, much like the example above. Otherwise your new money is "swamped" by a larger account going up and down every month.
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Old 02-22-2013, 04:28 PM   #6
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It sounds like the OP is adding to an existing portflio and using the value of the entire portfolio, not just the additions, to calculate the next buy-in. I think that's more of a recipe for adding to the portfolio when it's down than averaging in. The math isn't going to favor semi-equal additions. What if the market went down 10% and suddenly it looks like you're supposed to dump everything into the portfolio? which is not bad, maybe, but not VCA per my understanding.
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Old 02-22-2013, 06:02 PM   #7
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I think the problem is just as outlined...adding to a large existing portfolio and adding a relatively small amount such that the ups of the whole portfolio can obscure my addition...so I think I will,only consider how much the added amount is up in determining how much more or less to put in....so if the portfolio is up 4% more than I expected I will put in 96% of usual, and if it is down by 4% lower than what I planned I will put in 104% of the usual.
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Old 02-22-2013, 06:51 PM   #8
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I started using value averaging again last fall. (I first started in the spring of 2008, but dropped it in the chaos of that fall.) I set a target for the equity portion of my Roth IRA. I send contributions to the Roth every month, but they are directed to a bond fund until value averaging calls for a buy on the equity side. So far, there have been no buys. The best implementation is supposedly to check things once a quarter and make your moves then, or one can wait up to a month after the quarter ends since momentum may make delaying more favorable.

I think one should set a realistic to aggressive return rate. I used 7.5%/year since that is Vanguard's mid range projection for equities for the next 10 years. If VG is right, some times the market will be below that trend and you will buy and sometimes the market will be above trend and you will sell.

I have a record of my total portfolio value going back almost 30 years. Plotted with a log scale, it has a nearly linear overall trend line. In good markets the portfolio will very slowly climb higher than the long term trend line. Then there comes a sharp correction to below trend. From the low, the portfolio grows faster than trend and crosses the long term line again. I can see where value averaging might help avoid buying stocks when the portfolio has departed from the trend line on the high side or even sell some then. It should also help to encourage one to load up on stocks when on the low side of the trend line. (i.e. get greedy when others are fearful.)

I think there are two tricks to make it work. One, pick the right return assumption. Two, try not to start from a peak or a trough in market value, or at least make an adjustment to account for valuations. If one starts VA at a market peak and has a conventional, long term return assumption, it could be a very long time before one buys stocks again. (Starting from the dot com peak, one would still be waiting to invest.)
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Old 02-22-2013, 07:58 PM   #9
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Originally Posted by Svensk Anga View Post
I started using value averaging again last fall. (I first started in the spring of 2008, but dropped it in the chaos of that fall.) I set a target for the equity portion of my Roth IRA. I send contributions to the Roth every month, but they are directed to a bond fund until value averaging calls for a buy on the equity side. So far, there have been no buys. The best implementation is supposedly to check things once a quarter and make your moves then, or one can wait up to a month after the quarter ends since momentum may make delaying more favorable.
It would be interesting to really model your VCA against a normal DCA algorithm.

Just think about the two possible problems you allude to above.

You gave it up in 2008 right when you should have been "in" the most.

Also, when you get hooked in a good bull run like we have been in lately, you are not investing, so if the market never pulls back below earlier entry points you are losing a lot of money by being out of the market. This is actually the inverse scenario to what happened in 2008 - you are out because your VCA tool is waiting for a pullback which never comes. Of course maybe 2016 will be the next 2008 -- but who is going to bet their retirement on the market going down. That money that is piling up in the bond fund could likely vaporize before the market comes down far enough. That is what scares me about your strategy.

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Old 02-22-2013, 09:47 PM   #10
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I might have added that I used to be allocated nearly all equities plus emergency fund, but am now trending toward 70/30 by a retirement date maybe two years out. VA keeping me out of equities now is just getting my bond allocation down to something more conventional earlier. I set the VA path so as to get $X in bonds by my target date.

I went back into VA after seeing that William Bernstein suggested it for the withdrawal phase. DCA works for the accumulation phase (buy more shares when prices are low) but is not so good in the distribution phase. If you are selling to meet expenses DCA style, you sell more shares when prices are low. Not good for portfolio longevity. I am seeing if I can make VA work now so I can hopefully be comfortable with it in distribution. The goal is to do most of the selling when prices are on the high side.
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Old 02-23-2013, 07:51 AM   #11
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I might have added that I used to be allocated nearly all equities plus emergency fund, but am now trending toward 70/30 by a retirement date maybe two years out. VA keeping me out of equities now is just getting my bond allocation down to something more conventional earlier. I set the VA path so as to get $X in bonds by my target date.

I went back into VA after seeing that William Bernstein suggested it for the withdrawal phase. DCA works for the accumulation phase (buy more shares when prices are low) but is not so good in the distribution phase. If you are selling to meet expenses DCA style, you sell more shares when prices are low. Not good for portfolio longevity. I am seeing if I can make VA work now so I can hopefully be comfortable with it in distribution. The goal is to do most of the selling when prices are on the high side.
Could you clarify how that would work in withdrawal? Give a concrete example with real numbers, please?
Let me see if I understand with my own:
I have the proverbial $1M planning $40,000 withdrawal or $10000 per quarter. In January my portfolio is $990,000 and my expectation is 6% growth per year so 1.5% per quarter. But the last quarter it rose 6.8%. So now I have much more in portfolio than I planned, so I draw it back down to $990,000 x1.015? but now I have all of my year's worth of withdrawal. I am done for the year? Or do I keep drawing it off when it is over? Saving the extra for times when returns are negative?
So in a quarter when things are down below where I expect I don't take any from the portfolio but spend from my cash reserve? And do I put cash reserve into the portfolio when it is down to bring it up? Is there a study of this approach?
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Old 02-23-2013, 09:45 AM   #12
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I do not have an example of how VA would work in the distribution phase. Bernstein left that exercise for the reader. It seems well enough accepted in the accumulation phase to have some merit. I think it logical that the advantage should extend into distribution.

I found this independent assessment of how VA would have worked. Unfortunately, it has only one period tested and is not very long. (I would have preferred to send a link, but the page seems to have been taken down.) It out-performed DCA for the test period, accumulating cash near the end.
Attached Files
File Type: pdf VA Backtested on stock fund.pdf (1.01 MB, 7 views)
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Old 02-23-2013, 11:46 AM   #13
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Originally Posted by urn2bfree View Post

As I understand it--you pick a target return you expect to hit--for me maybe I set it too low..at 6% or 1.5% per quarter. If the value of my portfolio falls short, I put in enough to get it back to where it should be and then my usual quarterly input as well.
That's not how I understand VCA at all. This article explains it in a way that works for me. Instead, of picking your target return (as in OP), pick your investment amount and interval. It also considers the share price of whatever you're investing in (I suppose that could be extrapolated to your entire portfolio. I'll have to think about that.)

Anyway, say you want to invest $120,000 over the course of a year (roughly $10K/month). When you make your first investment of $10K, you look at the share price. Let's say it's $100/share - that's your baseline price. You invest the whole $10K the first month (100 shares). In the second month, look at the share price. Say it's now $104/share (4% higher). That means you'd invest 4% less in the second month, or $9.6K (~96 shares).

Here's an important point that no one has mentioned: $104 becomes your new baseline to which you compare the next month's investment. If you don't adjust your baseline, and your stock or fund keeps increasing in value, eventually you wouldn't be adding anything to it.

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Originally Posted by urn2bfree View Post
... my portfolio is more than double ...that would suggest putting nothing in? Or taking some out?
Another article I found helpful says "in certain circumstances, such as a sudden gain in the market value of your stock or fund, value averaging could even require you to sell some shares without buying any (sell high, buy low)." It also has a chart that shows the difference between holdings purchased through DCS vs. VCA.


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I am seeing if I can make VA work now so I can hopefully be comfortable with it in distribution. The goal is to do most of the selling when prices are on the high side.
I am interested in learning more about using VCA in distribution phase too.
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Old 02-23-2013, 12:12 PM   #14
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I might have added that I used to be allocated nearly all equities plus emergency fund, but am now trending toward 70/30 by a retirement date maybe two years out. VA keeping me out of equities now is just getting my bond allocation down to something more conventional earlier. I set the VA path so as to get $X in bonds by my target date.

I went back into VA after seeing that William Bernstein suggested it for the withdrawal phase. DCA works for the accumulation phase (buy more shares when prices are low) but is not so good in the distribution phase. If you are selling to meet expenses DCA style, you sell more shares when prices are low. Not good for portfolio longevity. I am seeing if I can make VA work now so I can hopefully be comfortable with it in distribution. The goal is to do most of the selling when prices are on the high side.
I do not use either VCA or DCA in my retirement. I have only two buckets, an income bucket, from which I don't touch any principal, made up of 20 dividend payers, and a growth bucket, which I could pull from if need be. I am staying away from bonds in this environment because I basically don't see any upside to owning them.

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Old 02-23-2013, 01:34 PM   #15
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I might have added that I used to be allocated nearly all equities plus emergency fund, but am now trending toward 70/30 by a retirement date maybe two years out. VA keeping me out of equities now is just getting my bond allocation down to something more conventional earlier. I set the VA path so as to get $X in bonds by my target date.

I went back into VA after seeing that William Bernstein suggested it for the withdrawal phase. DCA works for the accumulation phase (buy more shares when prices are low) but is not so good in the distribution phase. If you are selling to meet expenses DCA style, you sell more shares when prices are low. Not good for portfolio longevity. I am seeing if I can make VA work now so I can hopefully be comfortable with it in distribution. The goal is to do most of the selling when prices are on the high side.
I do something a little like that. I have a projection of the value of my portfolio at the end of each year, and plans to raise cash at the beginning of each year. If the market gets ahead of my projections and reaches my end of year value early I go ahead and raise the cash immediately. I can then spend that cash down before having to touch the portfolio. Given a reasonable projection, this is a good way to smooth equity gains while locking in gains that ensure your retirement plan is on target. I'm also willing to reinvest if the market drops 20% or more and have enough cash, though that's probably just getting greedy. I currently have 2 or 3 years of cash.
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