Tyler Hamilton’s bestselling book, The Secret Race, is contributing to one of the biggest pileups the professional cycling world has ever seen. A teammate of Lance Armstrong’s on the former U.S. Postal Service squad, Mr. Hamilton claims his old team was a chemically enhanced marvel.
One of their alleged doping methods (which, it should be noted, the team and Mr. Armstrong deny) is eerily similar to value averaging, an investment strategy with a history of juicing profits. But there’s an important difference: Value averaging is legal, and it’s perfectly suited to index fund investors like myself.
Mr. Hamilton asserts that his former squad, like many top teams, transfused blood from its best riders, months before the Tour de France. They infused it back when the race hit its toughest mountain stages. Michael Edleson’s classic book, Value Averaging , describes a similar process of asset infusion – with some equally impressive results.
To understand the appeal of his approach, you have to compare it to the more common practice of dollar cost averaging, which involves investing the same amount of money each month.
That’s not a bad strategy, but value averaging aims to do it one better.
With this strategy, you invest more money when markets are in a funk. You invest less when markets are rising.
The goal is to ensure you buy low and sell high. Occasionally, you’ll be taking small pieces of profits off the table; other times, you’ll be taking advantage of falling prices.
As described by Mr. Edleson, this approach would have outperformed dollar cost averaging with the Dow Jones industrial stocks in 57 of the 66 years between 1926 and 1991, earning 13.77 per cent annually, compared to 12.61 per cent.
Mr. Edleson’s book was updated in 2005 and showcased how the strategy would have performed during one of the most volatile periods in investing history: the Nasdaq’s rise and fall.
A standard chart of the tech-heavy index’s 2000 peak and its subsequent crash resembles a morale-crushing climb up – and down – one of the toughest mountain sections in the Tour de France. But value averaging would have smoothed out the ride, giving a Nasdaq index investor a 15.2 per cent annualized return between 1991 and 2005, compared to 9.6 per cent through dollar cost averaging.
If you’re ready to value average, you’ll require two things: discipline and an ironclad stomach. Pulling pieces from your winners and adding to your losers is easier said than done.
To see how the system works, assume you’re using a commission free TD e-Series Canadian equity index fund.
Say that you can invest $100 per month and that you have $10,000 to start. Split the $10,000 in two: put half in a money market account and half in the index fund. You then project how much you can reasonably expect to earn from your indexed portfolio. In this case, let’s project that the market will make 10 per cent a year over the duration of the investment.
At this rate, the $5,000 index would increase $500 for the first year, or $41.66 per month. If you add $100 to your investment in the first month, you will want the actual investment to increase $141.66 for the month ($41.66 from equity gains and $100 from your addition). To stay on pace, we’ll want the indexed investment to be worth $5,146 after the first month, $5,292 after the second month, $5,438 after the third month and so forth.
Each month, however, stock markets rise and fall. If the market rose after the first month, bringing the indexed investment to $5,146 before our second deposit, then we would have already met our target. Instead of adding more money to the index fund, we would take the $100 we were going to invest and add it to the money market fund.
Assume that the markets fell the following month, and our indexed investment dropped to $4,800. We would withdraw some cash from the money market account, topping up the index with the proceeds to reach the month end goal of $5,292.
If the markets go on a tear after that, surpassing our monthly projections, we engage in a bit of monetary transfusion. Each month the index exceeds our goal, we put the excess into the money market account.
Then when the economic climate gets tougher (like mountains in the Tour de France) we transfuse cash back into the markets when they drop. We stick to our projected growth for the funds – ten per cent per year – trying to ensure that the fund’s value neither rides ahead nor falls behind.
Nothing is certain in investing and I can’t guarantee this method will juice returns over the next couple of decades. But if you have the discipline to stick to the game plan, history indicates it can give you a boost in the race to make money.