Value Averaging - GBV

Value Averaging The Safe and Easy Strategy for Higher Investment Returns Michael E. Edleson Foreword by William J. Bernstein

1 8 O7

®WILEY 2 OO7

John Wiley & Sons, Inc.

Contents Foreword by William J. Bernstein Preface to the 2006 Edition Preface to the 1993 Edition Introduction

ix xiii xix 1

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Market Risk, Timing, and Formula Strategies RISK AND MARKET RETURNS Market Returns over Time Distribution of Market Returns . Risk and Expected Return MARKET TIMING AND FORMULA STRATEGIES Timing the Market Automatic Timing with Formula Strategies ENDNOTES 2006 NOTE

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Dollar Cost Averaging Revisited DOLLAR COST AVERAGING: AN EXAMPLE SHORT-TERM PERFORMANCE Over One-Year Periods Over Five-Year Periods LONG-TERM PROBLEMS WITH DOLLAR COST AVERAGING Growth Equalization SUMMARY ENDNOTES

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Value Averaging VALUE AVERAGING: AN INTRODUCTION SHORT-TERM PERFORMANCE LONG-TERM PERFORMANCE AND VALUE AVERAGING Linear, or Fixed-Dollar, Strategies Adjusting Strategies for Growth SUMMARY ENDNOTES 2006 NOTES

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Investment Goals with Dollar Cost Averaging BACKGROUND Lump-Sum Investments Using the Formula Annuities: Periodic Investments Dollar Cost Averaging and Annuities READJUSTING THE INVESTMENT PLAN The Readjustment Process Flexibility Down-Shifting Investment Risk GROWTH-ADJUSTED DOLLAR COST AVERAGING Exact Formula Approximate Formula Readjusting the DC A Plan SUMMARY ENDNOTES Appendix to Chapter 4: Constructing a DC A Readjustment Spreadsheet

57 57 57 59 60 63 63 64 66 69 71 72 74 75 80 80

Establishing the Value Path VALUE AVERAGING VALUE PATHS The Value Path Formula Flexible Variations on the Value Path Formula Readjusting the VA Plan A Cautionary Note An Alternate Method SUMMARY ENDNOTES Appendix to Chapter 5: Constructing a VA Readjustment Spreadsheet

87 87 88 89 92 93 93 94 95

Avoiding Taxes and Transaction Costs TAX CONSIDERATIONS WITH VALUE AVERAGING The Advantage of Deferred Gains Deferring Capital Gains Taxes: An Example A Compromise: No-Sell Value Averaging REDUCING TRANSACTION COSTS Limiting Taxes Limiting Costs SUMMARY ENDNOTES

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97 101 101 101 102 107 111 111 112 113 114

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Playing Simulation Games WHY SIMULATIONS ? WHAT AND HOW? Parameters Expected Return Expected Variability Randomness CONSTRUCTING THE SIMULATION An Example ENDNOTES Appendix to Chapter 7: Constructing a Simulation 2006 NOTE ENDNOTES TO APPENDIX TO CHAPTER 7 2006 NOTE 8 Comparing the Strategies FIVE-YEAR SIMULATION RESULTS Using Growth Adjustments No-Sell Variation Volatility TWENTY-YEAR SIMULATION RESULTS SUMMARY ENDNOTES 9 Profiting from Overreaction TIRING OF A RANDOM WALK Mean Reversion and Overreaction A Brief Look at the Data WHY DOES THIS MATTER? Timing ENDNOTES 2006 NOTE 10 Details: Getting Started USING MUTUAL FUNDS The Fund versus Stock Choice Index Funds Information on Specific Funds WORKING OUT THE DETAILS Using a Side Fund Operating Within a Retirement Account Establishing a Value Path

117 117 118 118 119 120 120 121 122 126 129 131 133 134 135 135 139 142 143 145 146 147 149 149 150 151 160 161 164 167 169 169 169 171 172 175 176 177 178

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2006 NOTE Setting Up a VA Value Path: An Example Other Important Considerations Using Guidelines and Limits NOTES FOR FINANCIAL PLANNERS Advanced Methods SUMMARY ENDNOTES 2006 NOTE

180 181 184 185 186 187 189 189 191

11 Examples: Strategies at Work THE GOAL AND INVESTMENT ENVIRONMENT Choosing an Investment Setting the Goal (Dealing with Inflation) How Much Should He Invest? INVESTMENT RETURN & TAXES Expected Return Taxes IMPLEMENTING DOLLAR COST AVERAGING 1981: Setting Up DCA 1982-1983 Investment Results 1983: Reassessment and Readjustment The 1985 Readjustment And So On and So On . . . Wrapping It Up: 1991 Results IMPLEMENTING VALUE AVERAGING Establishing the Value Path 1983: Readjusting the VA Plan Future VA Readjustments VA Investments SUMMARY KEY FORMULAS ENDNOTES

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12 A Final Word

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Index

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