#### Value-cost averaging?

In dollar-cost averaging, we invest a fixed amount of money into the stock market each period, purchasing variable units of the investment.

In value-cost averaging, we will invest an amount of money so that the value of our investments will be the same as if we had saved up a fixed amount of money every period and not investing it.

Let me give you an example to illustrate. If we do dollar-cost averaging, we might simply invest $100 each month into the STI. In value-cost averaging, we have to see what the value of our current investments is. We would buy units of STI so that the value of our investments is equal to $100 in the first month, $200 in the second month, and so on.

Say we bought 10 units of STI at $10 each in the first month, and they rise up to $15 in the second month. The total value becomes $150, which means that we must buy $50 worth of STI to make up to $200. We can buy 3 units giving a value of $45, totalling $195.

#### So how has value-cost averaging performed over the past ten years?

I did a backtest on ten years of data for the STI. For dollar-cost averaging, I invest $100 each month, regardless of the price of the STI. For value-cost averaging, I also assume that the value of my investments must grow by $100 each month.

Using dollar-cost averaging, I would have a total of 4,184 units of STI, giving me a portfolio value of $11,949.25 as of end October 2016. If I were to do value-cost averaging, I would have a total of 4,263 units, and a portfolio value of $12,714.87 as of end October 2016.

I had initially posted the full results onto this post, but because it takes up too much space, Blogger couldn't display everything. So, you can download the results and workings from here instead: workings.

#### Words of caution

From the results, it seems that value-cost averaging wins dollar-cost averaging. However, this is not true. Value-cost averaging prevents you from buying whenever the current price is higher than the average price you have bought at.

As a result of this, it benefits environments whereby the investments have been falling for long periods of time currently. This is exactly the environment of the STI now.

In other words, the total value of your value-cost averaging portfolio is limited more or less by how much you want it to grow by. Because stocks rise in the long run, it might not be a viable strategy in an inflationary environment.

EmoticonEmoticon