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Value Averaging: The Key to Surviving Market Downturns?

The performance of the stock market in 2022 was a very real reminder that risk management is extremely important in every investment environment. If you don’t have a strong risk management approach to investing, as last year showed us, you might be leaving yourself open to some dangerous and damaging volatility. 

It’s just a fact of investing life that the stock market is unpredictable.  There will be months or years where the market exceeds expectations, and there will be other times when it underperforms and winds up below where you expected it to be – sometimes, way below.  A good retirement plan, and a good investment strategy, should take this fact into account by aiming to capitalize on the up years and to be prepared for the down years with a defensive position. 

But how do you do that if it’s impossible to predict exactly when the next upswing or downturn will occur?  One way, potentially, is through a strategy known as Value Averaging.  The concept is somewhat similar to another strategy called dollar cost averaging, where a person buys shares of equities consistently as the values of those shares rise and fall over time, thus reducing the cost of the average share price over a period of years.

What is Value Averaging?

With Value Averaging, the idea is to sell certain assets when their gains are higher than expected and reallocate that cash to a less volatile area of your portfolio – one that’s not affected by the markets. You would then use those funds to buy into the market during times where it’s down.  In this way, we’re able to use the inherent market volatility potentially in your favor.  Taking cash during the good times allows you to stockpile some “dry powder” on the sidelines, and then buy when the market reverses course in the future and heads downward.   

Using the benefit of hindsight, I think I can say with confidence that if you’d done some value averaging at the end of 2021, when the markets were at their peak, you may have been much better off than if you’d simply let your gains ride on into 2022. The S&P 500 was up nearly 27 percent in 2021: a good year by almost any measure. Allowing those gains to work for you in future years is a vital component of a value averaging strategy. 

How Value Averaging Works

Here’s how it would work: let’s assume, hypothetically, that at the start of 2021, you decided on your growth portfolio that you’d be happy with any gains that exceed, say, 9 percent, just to make up a number. And then you found at the end of the year that the gains on your growth portfolio were roughly in line with the S&P, and your portfolio was up 27 percent. 

The Value Averaging strategy would have told you to take some or all of those excess gains – in this case 18 percent – and scrape them off the top so that you meet your expected goals. You would put them off to the side, and then, as the market declined in 2022, you’d have the extra money from the previous year’s gains to replenish what you lost – maybe buy in when the market is lower than expected. 

That’s what Value Averaging says to do. Unfortunately, human nature often tells us otherwise – keep those excess gains on the table and let it ride! That can work very well when the market’s going nowhere but up, but can do some real damage to a portfolio when the market takes a nosedive. 

If you’ve got a long time horizon — which is what you should have for your Bucket 3 growth portfolio — a value averaging strategy may work very well for you.  The key is consistency, discipline, and the ability to allow your portfolio the time it needs to take advantage of any potential growth.  

We can also apply this concept to a Buckets strategy to help us “refill” safe buckets that are being spent down to meet your monthly or annual retirement needs.  While the Buckets  strategy builds in a longer term time horizon for your growth buckets to try to shield you from some of that negative market volatility that happens, if performance has been better than expected, there’s no shame in using this excess growth to refill your safe buckets earlier than planned – just to take advantage of that unexpected GOOD market volatility. 

If it’s been a while since you last looked at how the volatility from last year may have affected your asset allocation, it may be time to do a quick review.  We do this all the time for our clients at Lucia Capital Group. How can we help you the most? Just give us a call. 

Important Information:

The information provided should not be considered specific tax, legal, or investment advice and is not specific to any individual’s personal circumstances.

Different types of investments and/or investment strategies involve varying levels of risk, and there can be no assurance that any specific investment or investment strategy will be profitable for a client's or prospective client's portfolio, thus, investments may result in a loss of principal.

Accordingly, no client or prospective client should assume that the information presented serves as the receipt of, or a substitute for, personalized advice from Lucia Capital Group or from any other investment professional.

You should always seek counsel of the appropriate advisor prior to making any investment decision. All investments are subject to risk including the loss of principal. This material was gathered from sources believed to be reliable, however, its accuracy cannot be guaranteed.

Value averaging and dollar cost averaging strategies do not guarantee a profit or protection from loss. Since such investment plans involve continual investment in securities, you must consider your willingness to continue purchasing during periods of high or low-price levels.

S&P 500 Index is an unmanaged index and includes a representative sample of large-cap U.S. companies in leading industries. An investment may not be made directly in an index.

Examples cited are hypothetical, are for illustrative purposes only, are not guaranteed and subject to potential federal and state law amendments. There is no guarantee that you will achieve the results discussed or illustrated.

Rick Plum is a registered representative with, and securities and advisory services offered through LPL Financial, a registered investment advisor and member FINRA/SIPC. The investment professionals are affiliated with LPL Financial and are conducting business using the name Lucia Capital Group, a separate entity from LPL Financial.

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