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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). Refer to a simple but detailed example here.

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

  1. 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.
  2. 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

  1. 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).
  2. 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.
  3. 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.
  4. 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.







22 Comments, Comment or Ping

  1. 1. Alain chiasson

    quickly reading this, I get the feeling that dva is more an investment strategy than a saving strategy, since you still need cash on a downturn. Dca is more saving into an investment account.

  2. We practice DCA but thanks for the heads up on DVA – we need to look into this a bit more closely!

  3. I knew about DCA, but this is the first time I have heard of DVA.

  4. 4. Returns Reaper

    DVA is covered in quite a bit of depth in Edleson’s “Value Averaging” (http://goo.gl/o3Mc0). Alain seems to share one of my main hangups with the strategy — if you have more money than you need to invest, what do you do with it? Put it in safe, low-yield investments? This really needs to be considered as part of the portfolio, and would lower the overall yield. And what if you need to invest more than you have? Do you borrow (leverage)? The cost of borrowing would also lower returns. These things aren’t adequately covered in the book, and while it is an interesting concept, it seems to be more academic than practical.

    I read in one of William Bernstein’s books (http://goo.gl/p6dh4 — Four Pillars I think?) that if you have a large sum of capital that needs to be deployed, DCA is usually less efficient than lump sum investing. DCA is a risk management strategy, but a better way of managing risk is to adjust the bond/equity ratio, as it gets you closer to the efficient frontier of risk/reward. But I haven’t seen any analyses of how DVA compares with lump sum investing in the context of the efficient frontier.

    Oddly enough, Bernstein still seems to be a proponent of DVA (he references it in his books and wrote the foreward for Edleson’s book). But he doesn’t address the issues of what to do with extra capital and where to get more capital when the strategy requires it.

  5. 5. sco

    DVA looks interesting, but you’d need to hold a portion of your assets in cash to have during downturns. I think I back-tested something similar to this last year (with XIU.TO as equity and XBB.TO as cash holder) and it produced better returns than DCA on XIU.TO.

  6. 6. Clark

    Thanks for the comments.

    @sco: Yes, it is true that a portion of the portfolio would need to be in cash, unless one has something like an opportunity fund for the purpose.

  7. 7. alexander45

    I’m not convinced that DVA produces enough of a benefit to warrant the risk of downturns and/or picking the wrong rate of return — especially when you include the opportunity costs of needing to hold reserves in cash, higher transaction costs (both buying and selling are required), more time required, etc.

    At its core, it is really nothing more than trying to time the market, which is considerably easier to do in hindsight or simulations than it is to do in reality.

  8. 8. Echo

    DVA sounds like a huge pain in the ass to manage. And there is no way the average investor would be able to stick with this strategy through highly volatile times like we’ve just been through.

    So, DCA is simple, DVA is a pain…how about something in between, like building up your cash until you have enough to make a worthwhile investment in a company that’s value priced?

  9. 9. sco

    DVA is not timing the market. DVA is not a TA strategy. It’s a money management strategy (like DCA). Of the two, DVA is superior. DVA has lower volatility. It also has higher returns most time (except during very strong and long bull markets). Money flows naturally into equities during downturns and into cash/bonds during bull markets.
    It’s a simple strategy to implement for beginners. Only two transactions each month and a spreadsheet.

  10. 10. Slacker

    I think I am unintentionally using an informal DVA. Basically, I add money to my retirement account regularly, and I’m suppose to rebalance when it gets too far from my allocation.

    But recently, prices of everything have gone up so much, I stopped buying. My cash position had increased to over 10% of my portfolio (I’m suppose to have 0%).

  11. 11. Ledtim

    There are several studies that arrives at the conclusion that dollar value averaging offers a slightly higher return than DCA. Here’s one comparing DCA vs DVA vs rebalancing.
    http://www.academyfinancial.org/09Conference/09Proceedings/%286C%29%20Chen,%20Estes.pdf

    But I don’t think most people have the discipline for DVA. It takes guts to invest the large amount (which is greater than simple rebalancing) DVA requires into the stock market when the market drops precipitously.

    Another important note is that the creator of DVA states that DVA is not for investing in individual stocks, which can go to $0. He recommends that you invest in the broadest possible index funds or etfs when using DVA.

  12. Nice post. I had not heard of Dollar Value Averaging before.

    You should not restrict yourself to one or the other. DCA has a purpose, especially in accounts such as RESP and possibly RRSP where you may add regular amounts slowly. Then you could always look at DVA once you hold a decent position that need to be rebalanced.

    DVA seem a little too formal to me. Do you do it per stock or per portfolio? I currently look at profit taking to rebalance. Looks like I just found the formal name but I am not too religious about the execution.

  13. 13. Scott

    I would think rebalancing your portfolio would make DCA equivalent to DVA.

  14. 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.

  15. 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.

  16. 16. jesse

    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?!?

  17. 17. Future-MoneyBags

    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

  18. 18. RuralDoc

    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

  19. 19. Clark

    @RuralDoc,

    Thanks for that spreadsheet link; I have something to play with now!

  20. 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.

  21. 21. cannon_fodder

    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.

  22. 22. Amit

    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.

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