A Multi-Market, Historical Comparison of the Investment Returns of Value Averaging, Dollar Cost Averaging and Random Investment Techniques

ABSTRACT As the title suggests, this paper compares two "formula" or mechanical investment techniques, value averaging (VA) and dollar cost averaging, to a form of random investing to determine if any technique yields superior investment return performance. The tests use historical market prices of chosen stock and commodity indices. Results seem to indicate that value averaging does provide a small but still superior expected investment returns under most conditions. Due to the relatively few real world "experiences " available, these results can only be anecdotally and not statistically confirmed at a high confidence level. Actual investment results reported here are consistent with prior statistically significant research supporting a small investment performance advantage for value averaging versus both other techniques using simulation to approximate market activity. Evidence builds that VA works! INTRODUCTION An earlier paper (Marshall and Baldwin, 1994) did a statistical comparison of simulation based investment results for Dollar-Cost Averaging (DCA) and random investment techniques. They calculated the internal rate of return (IRR) to an investor from each of many simulated investment scenarios under both techniques. Their research question was, "Does DCA yield superior investment performance compared to a purely random investment technique? " They found, with 99% confidence, that there is no statistical difference in the IRRs achieved by each technique. They also found, with 95% confidence that each technique had the same risk as measured by the standard deviation of the IRR distributions. They concluded that the null hypothesis was valid and that DCA was not superior to random investments. These results are contrary to most practitioner given investment advice, even including Vanguard's (Vanguard, 1988), and contrary to that presented in many texts on personal finance. See for example (Gitman and Joehnk, 2002.) To most academics those results are not surprising. The weak and semi-strong forms of the efficient market hypothesis (EMH) suggest that there should be no investment technique that persists in giving meaningfully superior performance over time, transaction costs considered. Admittedly, some techniques have temporarily given superior performance such as those investing in low P/E stocks, investing to take advantage of the "size effect" and even investing based on the January and other calendar related effects. see for example the works of (Fama and French, 1992 and Rosenberg, et al., 1985.) However, if the market is efficient, as the EMH obviously assumes, the benefits of such techniques should disappear as more and more investors participate in the anomalies to their hoped for advantage. What is interesting about tests of DCA and other purely mechanical techniques, that are influenced only by the absolute level of the stock market and its subsequent price fluctuations over time, is that the corrective mechanism suggested by the EMH can not work, since each investor may start using the technique at a different point in time and hence, at different stock price levels and thus receive investment signals at different price points and at different times. Edleson has proposed another such mechanical technique (Edleson 1988, 1991), somewhat similar to DCA, which he calls "Value Averaging" (VA). He has tested VA using simulations to compare VA to DCA and to the purchase of a constant number of shares in each investment period. Without considering possible differences in risk, he (Edleson, 1991, pp. 191 and 192) concluded: * "(There is an) inherent return advantage of value averaging (over dollar-cost averaging and purchase of a constant number of shares). " * "It's about as close to 'buy low, sell high' as we're going to get without a crystal ball. " If Edleson was correct, and there were no compensating risk differences, then this was an important development. …