Value Averaging Spreadsheet By AAII Staff Second Quarter 2011 Computerized Investing While the goal of most investors

is to buy low and sell high, some of us have the uncanny knack of doing just the oppositebuying at the very peak and selling at the very bottom. The market moves up and down, and very few investors have demonstrated the ability to consistently predict where it is headed over a long period of time. For someone looking to commit a large amount of money to the market, the specter of another market correction can be a disturbing thought. However, history has shown that sitting on the sidelines can be even more destructive, as we miss out on the superior longterm returns of the stock market. One way to counteract the fluctuations of the market, thereby reducing timing risk, is to follow a formula strategy that mechanically guides your investing. Perhaps the best-known formula plan is dollar cost averaging, whereby you invest a fixed dollar amount in an asset at equal intervals over a long period. As a result, more shares of a stock or mutual fund are purchased when prices are relatively low, while fewer shares are purchased when prices are relatively high. Over time, this strategy can lead to a lower average per-share cost, which, in turn, increases the rate of return. In the August 1988 AAII Journal, Michael Edleson introduced an alternate concept to dollar cost averaging called value averaging. Instead of investing a fixed dollar amount each period, you set the value of your investment holding to increase by a fixed amount or percentage each period. If share price increases alone cause the total value of your investment to increase above the planned periodic fixed increase amount, you must sell shares instead of adding to the investment. This investment accumulation strategy, which Edleson expands upon in his book Value Averaging: The Safe and Easy Strategy for Higher Investment Returns (John Wiley & Sons, 2006), is more flexible than dollar cost averaging, has a lower per-share purchase cost, and tends to have a higher rate of return. In this installment of Spreadsheet Corner, we revisit a value averaging spreadsheet developed in the July/August 2001 issue of CI by John Markese, former AAII president, and John Bajkowski, AAII president and former editor of Computerized Investing. Dollar Cost Averaging Versus Value Averaging Compared to dollar cost averaging, value averaging is a more aggressive approach because it forces you to invest more money when the market is falling and the total value of your holdings is decreasing. When the value of your holdings goes up, you invest less money buying the higher-priced shares, and there is the potential that you may need to sell shares. Choosing an appropriate long-term time horizon is key to successfully implementing an averaging strategy. Choosing a longer horizon will help you avoid the potential disaster of investing a substantial portion of your portfolio in the market at its high point. At a minimum, take two years investing monthly or quarterlyto complete your move into the market. More patient investors may choose a longer period, perhaps as long as five years. Investors who do not already have a significant pool of cash but do have cash periodically available are spared the temptation of rushing into the market all at once. While such investors are perfectly positioned for an averaging strategy, they may never start an investment program without a system such as this. Lastly, the frequency of your investments must be taken into consideration. Investing often enough over a uniform time interval is important. Quarterly or monthly investments are reasonable. Investing more frequently, such as weekly, is probably overkill, while investing less often is too infrequent and possibly defeats the benefits of diversifying over time in an ever-changing market. Value Averaging Spreadsheet Since the amount of money you need to invest with a value averaging strategy will change every period depending on the price movement in the security, a spreadsheet is a useful tool for calculating the periodic investment amount. While Edleson views the potential for forced sales as an advantage of value averaging, others view it in a negative light. Unless your investment is in a tax-sheltered account, you may be forced to pay capital gains taxes earlier than you otherwise had planned. Our value averaging spreadsheet allows you to set whether or not you wish to sell shares when the value of your fund increases beyond the

desired amount. The Value Averaging Spreadsheet tab in this worksheet uses the Vanguard Total Stock Market ETF (VTI) as an example in the spreadsheet. To use the spreadsheet, you first enter the initial investment amount in cell A5 and the dollar amount by which you want your investment to grow each period in cell A6. Allowing for two separate entries is useful since some funds require a higher initial investment than is required for subsequent purchases. The existence of two entries also allows you to apply a value averaging plan to an existing investment. To do this, you would input the current value of your holding in cell A5 and the desired periodic change amount in cell A6. If you wish to use value averaging to exit a position over time, enter a negative value in cell A6. Cell A7 is where you indicate whether you can purchase or sell fractional shares. Sales or purchases are normally done in whole increments for stock transactions, while mutual funds can usually be purchased or sold using fractional shares. Enter a 1 in cell A7 if you wish to deal with fractional shares, or a 0 if you do not. The message in cell B8 confirms your selection. Cell A9 is where you indicate if you wish to sell shares when your portfolio increases beyond the desired amount in a period. Enter 1 in cell A9 if you wish to sell shares; enter 0 if you do not wish to sell on those occasions. As confirmation, a formula in cell B10 will report how the spreadsheet calculates the reinvestment amount. Column A lists the date of each rebalancing. You can use any time period you wantsimply input the dates in column A. Column B automatically calculates the desired value of your holdings for each time period based on the values you enter in cells A5 and A6. Column C is where you input the net asset value or share price of the security. Column D allows you to enter any share amounts that you may have acquired, or sold, since the last time you rebalanced your portfolio. You would use this column to input any shares acquired through dividend reinvestment. Column D is also where you can adjust for any difference between the number of shares you instructed your fund or broker to buy or sell and the quantity actually transacted. Small differences are not uncommon because of the time lag. Column E sums the total number of shares from the last rebalancing and accounts for any differences entered in column D. Column F computes the total value of your holdings before the current rebalancingmultiplying the total number of shares reported in column E by the net asset value or share price in column C. Column G compares the current value of your holdings to the desired value and calculates how much money you need to invest or withdraw for the period. If you specified in cell A9 that you do not wish to sell any shares, a zero will appear in column G when your holdings go above the desired amount. Column H calculates the number of shares you need to buy or sell to rebalance, and column I estimates the number of shares you own after rebalancing. Column J keeps a running total of the amount you have invested in the security. Looking at Figures 1 and 2, we see that the average share price of VTI over the 25-month period is $53.64 (Cell C44). By comparison, the average share cost when we did not sell shares for rebalancing is $50.18 (Figure 1, cell J44) and $50.24 when we were selling shares for rebalancing (Figure 2, cell J44). Row 42 in both Figures 1 and 2 shows the share price of VTI one month after our final rebalancing (cell C42), along with the final portfolio value of $25,457 (cell J42). This value is used to calculate the internal rate of return in cell J45 using the XIRR function in Excel. The internal rate of return on an investment is defined as the annualized effective compounded return rate. Specifically, the IRR of an investment is the interest rate at which the net present value of costs (negative cash flows) of the investment equals the net present value of the benefits (positive cash flows) of the investment. This calculation uses the periodic cash flows over the 25-month investment period as well as the final portfolio value (which is viewed as a cash inflow at the end of the averaging period) along with the dates of these cash flows from Column A. It is important that the values in Column A are formatted as dates and not text, otherwise the XIRR function will not work. For a full listing of the underlying formulas used in this value averaging spreadsheet, you can refer to the online version of this article at ComputerizedInvesting.com or download the Value Averaging Spreadsheet from the AAII Download Library. Conclusion Dollar cost averaging and value averaging provide investors with a clearly defined investment plan. Having the path laid out before you should make the first steps much easier. Both averaging strategies

attempt to reduce one of the biggest fears faced by investorsinvesting a large sum of money into the market prior to a severe market downturn. John Markese, former president of AAII, John Bajkowski, president of AAII, and Wayne A. Thorp, CFA, editor of Computerized Investing, contributed to this article.

A B C D E F G H I 1 Value Averaging Worksheet, Second Quarter 2011 Computerized Investing 2 3 Ticker VTI Security Vanguard Total Stock Market ETF 4 5 $1,000 Dollar Amount of Initial Investment 6 $1,000 Dollar Amount of Increase Desired Each Period 7 0 << Purchase Fractional Shares? (Enter 1 if Yes, 0 if No) 8 Fractional shares WILL NOT purchased 9 1 << Do You Wish to Sell Shares to Force Portfolio to Maintain Desired Value? (Enter 1 if Yes, 0 if No) 10 Shares WILL be sold to keep portfolio at desired level 11 12 No. of No. of 13 Share Shares Shares Total Amount No. of Shares 14 Price Acquired Owned Value to Shares Owned 15 Desired or Since Last Before Before Invest to Buy After 16 Date Value NAV Rebalancing Rebalancing Rebalancing (Redeem) (Sell) Rebalancing 17 2/2/2009 $1,000 40.84 0.000 $0.00 $1,000.00 24.000 24.000 18 3/2/2009 $2,000 35.59 24.000 $854.16 $1,145.84 32.000 56.000 19 4/1/2009 $3,000 39.73 56.000 $2,224.88 $775.12 20.000 76.000 20 5/1/2009 $4,000 44.01 76.000 $3,344.76 $655.24 15.000 91.000 21 6/1/2009 $5,000 47.28 91.000 $4,302.48 $697.52 15.000 106.000 22 7/1/2009 $6,000 46.60 106.000 $4,939.60 $1,060.40 23.000 129.000 23 8/3/2009 $7,000 50.44 129.000 $6,506.76 $493.24 10.000 139.000 24 9/1/2009 $8,000 51.13 139.000 $7,107.07 $892.93 17.000 156.000 25 10/1/2009 $9,000 52.78 156.000 $8,233.68 $766.32 15.000 171.000 26 11/2/2009 $10,000 52.44 171.000 $8,967.24 $1,032.76 20.000 191.000 27 12/1/2009 $11,000 55.78 191.000 $10,653.98 $346.02 6.000 197.000 28 1/4/2010 $12,000 57.10 197.000 $11,248.70 $751.30 13.000 210.000 29 2/1/2010 $13,000 54.96 210.000 $11,541.60 $1,458.40 27.000 237.000 30 3/1/2010 $14,000 56.70 237.000 $13,437.90 $562.10 10.000 247.000 31 4/5/2010 $15,000 60.39 247.000 $14,916.33 $83.67 1.000 248.000 32 5/3/2010 $16,000 61.43 248.000 $15,234.64 $765.36 12.000 260.000 33 6/1/2010 $17,000 55.38 260.000 $14,398.80 $2,601.20 47.000 307.000 34 7/1/2010 $18,000 52.25 307.000 $16,040.75 $1,959.25 37.000 344.000 35 8/2/2010 $19,000 57.26 344.000 $19,697.44 ($697.44) (12.000) 332.000 36 9/1/2010 $20,000 54.73 332.000 $18,170.36 $1,829.64 33.000 365.000 37 10/1/2010 $21,000 58.66 365.000 $21,410.90 ($410.90) (7.000) 358.000 38 11/1/2010 $22,000 60.87 358.000 $21,791.46 $208.54 3.000 361.000 39 12/1/2010 $23,000 62.16 361.000 $22,439.76 $560.24 9.000 370.000 40 1/3/2011 $24,000 65.55 370.000 $24,253.50 ($253.50) (4.000) 366.000 41 2/1/2011 $25,000 67.06 366.000 $24,543.96 $456.04 7.000 373.000 42 3/1/2011 68.25 Final Value: 43 Total Net Cost: Avg Share Price or NAV: 53.64 44 Average Net Cost Per Share: 45 Internal Rate of Return:

Total Invested $1,000 $2,146 $2,921 $3,576 $4,274 $5,334 $5,827 $6,720 $7,487 $8,519 $8,865 $9,617 $11,075 $11,637 $11,721 $12,486 $15,087 $17,047 $16,349 $18,179 $17,768 $17,977 $18,537 $18,283 $18,739 $25,457 ($18,739) 50.24 28.1%

Periodic Investment (1,000.00) (1,145.84) (775.12) (655.24) (697.52) (1,060.40) (493.24) (892.93) (766.32) (1,032.76) (346.02) (751.30) (1,458.40) (562.10) (83.67) (765.36) (2,601.20) (1,959.25) 697.44 (1,829.64) 410.90 (208.54) (560.24) 253.50 (456.04) $25,457

Formulas for Value Averaging Spreadsheet A3: B3: D3: E3: A5: B5: A6: B6: A7: B7: B8: A9: B9: B10: E12: I12: C13: D13: E13: F13: G13: H13: I13: C14: D14: E14: F14: G14: H14: I14: B15: C15: D15: E15: F15: G15: H15: I15: J15: K15: A16: Ticker VTI Vanguard Total Stock Market ETF

1000 Dollar Amount of Initial Investment 1000 Dollar Amount of Increase Desired Each Period 0 << Purchase Fractional Shares? (Enter 1 if Yes, 0 if No) =IF(A7=1,"Fractional shares WILL be purchased","Fractional shares WILL NOT purchased") 0 << Do You Wish to Sell Shares to Force Portfolio to Maintain Desired Value? (Enter 1 if Yes, 0 if No) =IF(A9=1,"Shares WILL be sold to keep portfolio at desired level","Shares WILL NOT be sold to force portfolio to de No. of No. of Share Shares Shares Total Amount No. of Shares Price Acquired Owned Value to Shares Owned Desired or Since Last Before Before Invest to Buy After Total Periodic Date

old to force portfolio to desired level")

B16: C16: D16: E16: F16: G16: H16: I16: J16: K16: A17: B17: C17: E17: F17: G17: H17: I17: J17: K17: A18: B18: C18: E18: F18: G18: H18: I18: J18: K18: I42: J42: K42: I43: J43: A44: B44: I44: J44: I45: J45:

Value NAV Rebalancing Rebalancing Rebalancing (Redeem) (Sell) Rebalancing Invested Investment 2/2/2009 =$A$5 40.84 0 =E17*C17 =IF(B17-F17<0,IF($A$9=1,B17-F17,0),B17-F17) =IF($A$7=0,ROUND(G17/C17,0),ROUND(G17/C17,3)) =H17 =G17 =0-J17 3/2/2009 =B17+$A$6 35.59 =I17+D18 =E18*C18 =IF(B18-F18<0,IF($A$9=1,B18-F18,0),B18-F18) =IF($A$7=0,ROUND(G18/C18,0),ROUND(G18/C18,3)) =E18+H18 =G18+J17 =J17-J18 (Copy formulas in cells B18 and E18:K18 down as many rows as necessary. Final Value: =I41*C42 =J42 Total Net Cost: =SUM(K17:K41) Avg Share Price or NAV: =AVERAGE(C17:C41) Average Net Cost Per Share: =-(J43/I41) Internal Rate of Return: =XIRR(K17:K42,A17:A42)

as many rows as necessary.