Craig Israelsen, Ph.D. faculty in the Department of Consumer & Family Economics, University Missouri-Columbia and contributing editor Financial Planning, has focused his academic career on the study of the individual investor and the mutual fund industry. His current book, The Thrifty Investor, soon to be published by McGraw-Hill, discusses value-cost-averaging in depth and presents it as an important management approach for the successful investor. A passage appears below:
".....Armed with this new "emotionally-insulated" perspective, regular folks become thrifty investors who can take dollar cost averaging to the next level - value cost averaging. Value cost averaging requires that additional money be invested (if possible) when prices have declined. In other words, we go shopping when our investments are "on sale". Why? Very simply, the goal of investing is to purchase as many shares as possible (of a stock or mutual fund) at the lowest possible price and then sell our shares at the highest possible price in the future. Or, more succinctly, buy low and sell high. It simply is not possible to know the exact moment that the price of our stock or mutual fund has bottomed out or hit its ultimate high. So, a practical alternative is to invest additional funds in your investment accounts when their value has declined a pre-determined percentage amount, say 10 percent. A unique web-based software tool that helps investors manage their mutual fund accounts using a value-cost averaging technique is at www.fundbuilder.com.
For example, say you have invested $50 each month into a mutual fund account. After one year, the account has a value of $680. Thus, you have invested $600 and have "made" $80 in gains. Let's say that two months later (and you've invested another $100 @ $50 per month) your account value is $615. You've invested $700 and "lost" $85, which is more than a 10% decline in value compared to what has been invested. (A loss of $70 in account value would represent a 10% decline in an account in which $700 has been invested). At this point, the investor would consider investing some additional money, say an extra $50 into the mutual fund account.
Putting into practice the "buy low" part of the "buy low, sell high" mantra requires that investments be made when prices have gone down. It sounds easy, but is surprisingly hard to do. When prices are falling many trigger-happy investors want to bail out. They panic. Value cost averaging forces the opposite behavior. Instead of selling low in a moment of panic, value-based investors buy additional shares at lower prices. It's a simple approach that doesn't require much analysis, just a little attention and courage. It's the stuff thrifty investors are made of."