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Chapter
1
INTRODUCTION
Statement
of the Purpose
Today’s business world has become a fast-paced environment
where few people are able to simply get a good job, work for the same
employer for thirty years, and retire on a comfortable pension.
Instead, companies are no longer loyal to the employees;
they are laying people off as soon as contracts are lost or new
executive management decides to enhance the bottom line.
These trends are not necessarily bad;
they do enhance competition and make
America
more productive. However,
these trends have created an environment that forces the American worker
to take care of his own future by planning his own finances.
Furthermore, American workers are under greater stress due to the
fear of losing their jobs due to competition, failing companies, etc.
Understandably, today’s employees want to make their money work
as hard as they do and in more and more cases, they want to retire
early.
As a result of these changes in
America
’s culture, the financial industry is exploding.
The middle class especially is working longer hours and under
greater stress just to break even, and they typically do not have time
to dedicate additional hours to analyze stocks and bonds and monitor
their own portfolios. Thus,
new mutual funds, where professional investors invest a large pool of
money from thousands of individual investors, are created almost every
month. In fact, there are
now over two or three times as many mutual funds as there are stocks on
the New York Stock Exchange. The
financial planning business is booming, and new financial magazines,
newsletters, and newspapers are popping up with nearly every trip to the
bookstore.
Unfortunately, however, the techniques of investing in mutual
funds have not changed much over the last fifteen to twenty years.
If you pick up nearly any issue of any financial magazine or
speak to any financial professional, the first investment technique you
will see or hear is “Dollar Cost Averaging.”
If you dig a bit further, you may also come across another
popular technique called “Asset Allocation.”
Both of these techniques are described in more detail later.
However, in my personal quest for higher investment returns over the
last fifteen or so years, I came across a small booklet by Ken Roberts
called, Dollar Value Averaging:
How to Profit from Volatile Markets.
This little booklet spoke of a technique that produced
significantly higher returns with lower risk than the traditional,
conservative techniques discussed above.
However, when I began trying to implement the plan in real
investment vehicles, there were many questions unanswered by this
publication. So, I created a
few spreadsheets and performed a bit of analysis and began deriving my
own answers to questions such as the ones listed below:
•
What do you do if you are only allowed six exchanges per year?
•
What do you do if the theory says cash in $78 worth of shares and
the fund limits you to $100 minimum redemptions or exchanges?”
•
Is it better to invest in “aggressive growth” funds (i.e.,
high volatility) or more stable “balanced” funds?
The
preliminary answers derived were counter-intuitive in some cases.
It became apparent that this technique did have high potential,
but there was a need to create a step-by-step plan appropriate for the
masses that want to maximize returns and simultaneously minimize risk
and effort.
If you are looking for a simple way to make your money work
harder for you, increase your investment returns, and lower your risk
with only a little more effort than the traditional, “old standby”
techniques, the information that follows may be of great interest to
you. Dollar value averaging
is flexible in scope and can be used to generate very large balances,
provide a way to automatically transfer money from the riskier stock
market to less risky money markets as one approaches retirement, or
create a money machine that continues to generate cash income to you
long after you have taken back all the money you ever invested.
The results of this study can provide significant benefits to
both business and individuals in the area of wealth accumulation.
In business, for example, methods of corporate investment can be
altered to increase profits on “idle” cash.
For individual investors the
research shows how one can effectively create a "money
machine" depending on the characteristics of the investment
vehicle, the long-term base growth rate, and volatility.
This concept could also become a keystone in retirement planning
of the future.
Statement
of the Problem
As stated above, two of the most popular automatic investing
techniques for maximizing returns while lowering risk are “dollar cost
averaging” and “asset allocation.”
Briefly stated, dollar cost averaging is a technique where the
investor makes a periodic, fixed-amount investment in a variable-priced
security (e.g., stocks, bonds, mutual funds, etc.).
Asset allocation is the process of allocating fixed percentages
of funds between multiple investments and maintaining those percentages
(Quinn, 91). Though the
enhanced performance of dollar cost averaging and asset allocation over
the traditional “buy and hold” philosophy is well documented and
proven, investors always want more (Murdoch, 92; Sivy and Scherreik,
95). Another lesser-known
technique called dollar value averaging, or value averaging, is
presented sparsely in the literature as one technique that does go a
step further by increasing returns and lowering risk (Edgerton, 91) at
least with respect to dollar cost averaging;
no references have been found that compare the results of value
averaging to asset allocation. Dollar
value averaging puts a twist on the concept of dollar cost averaging;
rather than investing a specific amount every period, the amount
invested is varied to make the value of the account grow by a specific
amount each period.
Most of the literature discussing value averaging provides
high-level discussions of the technique and how to perform the
technique. However, none of
these sources provide a detailed step-by-step value averaging plan for
the small investor. When
considering the small investor, there are several real-world issues that
become significant to the actual implementation of value averaging.
Furthermore, the literature does not characterize when, and for
which types of investment, value averaging most significantly
out-performs the other popular investing techniques.
Thus, this study is conducted to mathematically predict and
empirically verify the performance of value averaging with respect to
dollar cost averaging and asset allocation taking into consideration
real-world issues such as minimum additional investments, volatility,
commissions, etc. The
difference in return on investment between value averaging, dollar cost
averaging, and asset allocation is quantified for several simulated
scenarios as well as for historical data.
Finally, a step-by-step investment plan for the small investor is
presented.
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