Value averaging plans (VAPs) are an innovative and powerful way to invest regular amounts. They go beyond traditional regular savings plans (RSPs) that rely solely on dollar cost averaging. With VAPs you aim to automatically take advantage of market volatility by investing more when markets decline, and less when markets appreciate.

In contrast to RSPs, also known as dollar cost averaging (DCA), which rely on a fixed investment amount at each period, value averaging dynamically adjusts these amounts in response to markets. Investors may invest nothing in some months, a large amount or a small amount. The concept is shown in Figure 1 below.

Value averaging works on the idea that as an investor you want to increase your portfolio by a certain value over time, for example, $1000 each month. Some of this value you could contribute as an incremental investment each month, perhaps coming from your bank account using GIRO, but some of it you hope to come from the gains in your existing portfolio due to market increase.

So, for example, in a good month your current portfolio may gain by $800 due to the markets. A VAP would recognise that you need only to add $200 to your portfolio from your bank in that month to keep on track for the $1,000 of value added. In contrast, when markets are less kind your portfolio could actually decline by $350 in one month. In this month VAP would recognise that you need to add $1350 of fresh money to your portfolio to keep on track. The net result is that when markets are trending up your bank account is called on less. When markets decline your fresh investments increase. It's simply a twist on the idea of buying low.

Research suggests that the method results in higher returns at a similar risk, especially for high market variability and long time horizons. Simple illustrative examples are shown below.

Extremely volatile markets: VAP versus traditional RSP
Value add target of $1,000. Illustrative only. Source: dollarDEX

In addition to the basic idea discussed above, value averaging incorporates another feature absent in dollar cost averaging - the target annual return of the portfolio. The investor provides this information when he or she starts the VAP. This extra information is used by the value averaging formula to ensure a pre-determined level of portfolio growth*. So as well as trying to add $1,000 each month the investor is trying to grow the portfolio at, say, a level of 8% per year. The VAP formula is smart enough to do both.

dollarDEX VAP also allows investors to set a maximum and minimum dollar amount for fresh money to invest per month. This is to avoid surprise withdrawals of very large amounts from your bank account, for example, when markets have corrected severely.

dollarDEX VAP also allows investors to choose a benchmark to determine the state of the market at the point of investment each month. This is used to calculate the amount of fresh money needed to satisfy the value added target. To avoid the problem of delayed unit trust prices (typically behind the market by 2-3 days) investors may use a proxy for the "missing" fund prices, such as the relative value of the STI. This helps to keep the VAP formula up-to-date on markets.

VAP is now available exclusively at dollarDEX,for cash, CPF and SRS investments. With cash and SRS investments you need to have at least two months of fresh investment as "seed money" (which would be $2,000 in the example above) in a cash management fund, and optionally to have a GIRO set up on the account you use for value averaging.

Summary

Useful for gradual investment of lump sums (not only for regular savings), VAP helps you take advantage of market volatility by automatically investing more when markets are down, and less when markets are up. You can set two main parameters to VAP:

• Amount of value to add each month, for example, $1,000.
• Growth rate of the portfolio, for example, 8% per year.

And if using cash or SRS you need holdings in a cash management fund, which is used to pay for the monthly VAP investment. So to ensure payment for the VAP each month you must top up your holding in your nominated cash management fund from time to time (using Invest), or you set up a GIRO account so that we can automatically top up for you.

*Of course, if your target return is unrealistically high and markets are in the doldrums you probably won't meet your hoped-for return in the short-run, or you may find that your monthly GIRO deduction is very high in order to keep the portfolio growing at the high rate.