Foreword
Since its first printing in 1991, the cachet of Value Averaging has steadily grown to cult-classic status. So reluctant are its readers to part with the two original editions that these humble volumes have turned out to be highly profitable investments in and of themselves. The closure of the book’s original producer, International Publishing Company, was followed by the exhaustion soon thereafter of the planet’s last remaining supplies at a redistributor in, of all places, Cave Junction, Oregon; prices for used copies thereupon sailed into territory more typically seen with F. Scott Fitzgerald first editions.
Why, for the past several years, have investors been willing to pay hundreds of dollars for one thin paperback? The reputation of an investment classic usually issues in no small part from its literary qualities: the velvety logic of Benjamin Graham’s The Intelligent Investor, the good humor and powerful exposition of Burton Malkiel’s A Random Walk Down Wall Street, the moral thunder of John Bogle’s Common Sense on Mutual Funds, or the narrative elegance of Edward Chancellor’s Devil Take the Hindmost. While Mike Edleson’s Value Averaging is nothing if not well written, it qualifies as essential investment reading for an entirely different reason. Simply put, Mike Edleson’s book is the single best guide on the mechanics of deploying a steady stream of cash into a portfolio. I’ll go one step further: It is the only book that fully describes how any investor, from the smallest 401 (k) participant to the largest pension fund manager, can fully harness this powerful discipline.
The power of the value averaging method derives from its marriage of two proven but heretofore separate techniques: dollar cost averaging and portfolio rebalancing. The mathematical imperative of dollar cost averaging, the time-honored purchase of equal, periodic amounts of stocks, forces investors to buy more shares of stock or mutual funds when prices are low than when they are high, increasing overall returns, on average. Rebalancing, on the other hand, is most often applied to mature portfolios and mandates the periodic adjustment of portfolio allocations back to a set policy, forcing a strong element of “buy-low/sell-high” discipline into an investor’s trading decision making.
Mike’s special genius lay in realizing that these two techniques could be combined in the accumulation phase of a portfolio; not only are more shares bought when prices are low and fewer shares when prices are high, as with dollar cost averaging, but more money is deployed into stocks when prices are low and less when prices are high, producing yet more salutary long-term results.
Any investor fortunate enough to have come across Value Averaging during the 1990s and absorb its message was amply rewarded; prices defied both logic and gravity as that fateful decade wore on, and the technique told its practitioners to invest progressively less money on high-priced equity. Then, as prices plunged between 2000 and 2002, the hoards of capital accumulated during the previous several years was used to purchase shares at bargain-basement prices.
No investment technique, of course, works 100 percent of the time. Regular portfolio rebalancing, for example, usually increases portfolio returns, but it does not always do so. When markets move strongly up or down for a long period of time, such as occurred during the 1990s in the United States (up) and in Japan (down), rebalancing can hurt portfolio returns by the continuous purchases of a falling asset or the continuous sales of a rising asset. The same is also true of value averaging into an asset class over a period of relatively few years in a generally rising market, in which case the investor would have been better off purchasing a single lump sum.
Most investors, of course, will be adding to their portfolios for many decades. Here, the risks of a “bad draw” are far less, but still not zero, and are mainly the result of misjudging the long-term market return, one of the technique’s central inputs. Grossly overestimating this value will result in the purchase of too much stock, possibly exceeding the saving capacity of the investor, whereas grossly underestimating this value will result in too little stock being purchased.
The past few decades have seen a tectonic shift in the retirement landscape, with the replacement of the traditional definedbenefit retirement plan with a slew of defined-contribution schemes, prime among which is the 401 (k) account. The net effect of this radical alteration of the retirement savings paradigm has been the conscription of tens of millions of employees into becoming their own unwilling portfolio managers—in essence, a vast and unprecedented experiment in social engineering. For the vast majority of participants, untrained in basic finance and provided with mediocre investment vehicles, it will end badly. The few who will do well will be those who have read and absorbed the messages of the volumes listed at the beginning of this foreword, and in the order listed. Value Averaging is, if you will, the essential chocolate-sauce-and-cherry topping on the parfait, providing, in normal circumstances, an additional reward in excess to that obtained by assembling a disciplined, low-cost, diversified portfolio.
An investment strategy is much like the blueprint for a skyscraper. It is one thing to understand how the steel and concrete elements are assembled, and it is quite another to be welding rivets on an exposed girder 60 stories above a city street. While Value Averaging is a necessary and essential element in the assembly of a sound portfolio, it is most certainly not sufficient. First, you must actually be able to save. Perhaps you can pick securities as well as Warren Buffett, but if you are unable to put away a substantial percentage of your income, you are doomed.
Second, and just as important, you must be able to execute. The discipline of value averaging mandates that when everyone around you has panicked, not only must you keep your head and continue to purchase stocks, you must do so in far larger amounts than in more normal times. This will be particularly true if you are well along in the process, as the large amount of stock assets already in your portfolio will leverage up the amount of necessary purchases in the event of a bear market. As the old cliché goes, no balls, no blue chips: Some will have the knowledge, but not all will have the moxie.
At the risk of overburdening the reader with too many metaphors, the investment process can be likened to a sporadic, interminable war against both the markets and the “enemy in the mirror”—one’s own emotions. While Dr. Edleson cannot supply you with the courage necessary to confront these frightful adversaries, he can at least provide you with the training, weapons, and body armor with which to do battle in the capital markets.
—William J. Bernstein