ACTA UNIVERSITATIS AGRICULTURAE ET SILVICULTURAE MENDELIANAE BRUNENSIS

Volume 63 235 Number 6, 2015

http://dx.doi.org/10.11118/actaun201563062151

APPLICATION OF THE VALUE

AVERAGING INVESTMENT METHOD
ON THE US STOCK MARKET

Martin Širůček1, Ivana Škatuĺárová2

1
Department of Finance, Faculty for Business and Economics, Mendel University in Brno, Zemědělská 1, 613 00
Brno, Czech Republic

Abstract

ŠIRŮČEK MARTIN, ŠKATUĹÁROVÁ IVANA. 2015. Application of the Value Averaging Investment
Method on the US Stock Market. Acta Universitatis Agriculturae et Silviculturae Mendelianae Brunensis, 63(6):
2151–2160.

The paper focuses on empirical testing and the use of the regular investment, particularly
on the value averaging investment method on real data from the US stock market in the years 1990–
2013. The 23-year period was chosen because of a consistently interesting situation in the market and
so this regular investment method could be tested to see how it works in a bull (expansion) period
and a bear (recession) period. The analysis is focused on results obtained by using this investment
method from the viewpoint of return and risk on selected investment horizons (short-term 1 year,
medium-term 5 years and long-term 10 years). The selected aim is reached by using the ratio between
profit and risk. The revenue-risk profile is the ratio of the average annual profit rate measured for
each investment by the internal rate of return and average annual risk expressed by selective standard
deviation. The obtained results show that regular investment is suitable for a long investment horizon
or the longer the investment horizon, the better the revenue-risk ratio (Sharpe ratio). According to
the results obtained, specific investment recommendations are presented in the conclusion, e.g. if
this investment method is suitable for a long investment period, if it is better to use value averaging
for a growing, sinking or sluggish market, etc.

Keywords: regular investment, value averaging, risk and profit profile, standard deviation, crisis
period, US market, S & P 500

INTRODUCTION that the investor does not make a loss, because

Investment into stock markets is suitable for the index can possibly react very sensitively and
investors who have enough available finance and for example, sink in response to developments in
who require higher yields, as well as for those who the economy and expectations.
are ready to accept a higher level of risk. These This is why investors look for investment methods
markets are characterized by higher volatility offering some profit and the possibility of also
(standard deviation) over a short time, but by making a gain through intensive falls or market
a growth trend for a long investment horizon. It reductions. The value averaging investment method
is precisely the higher volatility (variation) which works on a simple principle: that the portfolio value
is the greatest disadvantage for investment on grows according to a given value (e.g. USD 1,000,
the stock market. Consequently, investors search EUR 100 per month). This investment method
for ways of eliminating (minimzing) the risk of loss. offers to buy shares when market prices are sinking
A good method of risk reduction is diversification and to sell them when prices are growing. Thus it is
via stock indices, where many companies cover one possible that this method is profitable also through
investment into one index and the risk is spread over negative movements and falls.
a wide range of stocks. However, this investment The value averaging investment method combines
style (passive investment strategy) cannot guarantee some characteristics of dollar cost averaging and
portfolio rebalancing. This investment strategy was

2151
2152 Martin Širůček, Ivana Škatuĺárová

developed by Prof. Michael E. Edleson in 1988. dollar cost averaging, investors can not only buy
According to Marshall (2000), the pivotal point of new shares, but they can sell them too, and it is not
this method is a precisely set mathematical process, necessary to invest a fixed and constant amount of
which consists of the regular investment of a given money during the whole investment period.
amount of money for a defined period of time (e.g. The function of value averaging is described in
for 1, 3, 5, 10 years or a longer investment period). the following example of investment in a growing
This is how investors can manage their portfolios stock market. The investor sets an investment target
so that their value grows by the same amount in of USD 2,000 over the next five months with an
regular periods. Thanks to this, value averaging can initial investment of USD 400 (2000:5). The market
be considered a type of regular investment although price in the first period (month) is USD 5 per share
investors do not invest the same sum for example and the investor buys 400 shares. At a market
every month as by the dollar cost averaging method. price of USD 8 in the next period, the target value
The biggest difference between value averaging of the portfolio will be USD 800. According to
and dollar cost averaging is that with dollar cost the investment target, the investor buys 20 shares,
averaging, the investor makes a regular investment each for USD 8. So the regular investment in
with the same amount of money (e.g. each month), the second period (month) is USD 160. Since in
while with value averaging, the amount of money the third period, the price grew to USD 10 per share
regularly invested is varied. With value investment and because the target value of the portfolio in that
the investor has to reach the nominal investment month was USD 1,200, the investor had to buy 20
goal, which is divided into the whole investment shares. In the following month, the price is also USD
period (see below). So the investor can react to 10 and according to the target value of USD 1,600,
actual development on the market, allowing not the investor buys 40 shares. A
er four investment
only buying but also selling of assets. periods, the investor owns 160 shares. In the last
Varga (2011) mentioned that it is a specific feature period, the price grew to USD 16 and the portfolio
of this investment method that the portfolio value in this period had to be equal to the target
grows every month (if not set otherwise) by value of USD 2,000. Thanks to the price increase,
a constant amount of money no matter what the investor can sell a portion of the shares (35 units)
market developments and fluctuations there are. and will own altogether 125 units (125 · 16 = 2000) at
As a result, investors buy more shares at the time of the end of the whole period.
a downtrend and the frequency of buying is lower According to this strategy, the investor has to
at the time of growth. The mathematical formula is think about the amount that needs to be saved.
set so that owned shares are sold at a time of high Before starting to save, the investor determines an
value. Edleson (2007) states that in comparison with investment goal (nominal value) which he wants

I: The principle of value averaging investment method

Market price Required value Owned unions Bought unions Regular investment
Period
(USD) (USD) (pcs) (pcs) (USD)
1 5 400 80 80 400
2 8 800 100 20 160
3 10 1 200 120 20 200
4 10 1 600 160 40 400
5 16 2 000 125 −35 −560

1: Regular vs. lump sum investment

Source: Guili (2015)
 Application of the Value Averaging Investment Method on the US Stock Market 2153

to accumulate. This value consists of an initial Compared to dollar cost averaging, the most
investment and an amount of regular investment. important difference is the possibility of selling
Nevertheless, it is not a “core” regular payment in shares. It is also the most typical and most
the sense of how much is invested in each selected interesting fact of this strategy. However, it is not
period. It is meant as a value, which regularly possible to eliminate the risk of bad timing; this
increases a portfolio (Marshall, 2006). method provides much more recognizable signals
An easier explanation of this method is described about the phase in which the market is (Edleson,
by Hayley (2010) as an investment strategy which 2007). If the market reaches its top, the value
can be shown to achieve lower average costs and averaging mechanism will induce the investor to
a higher internal rate of return than alternative sell the shares. In the case of an opposite situation,
strategies. when the market goes down and the shares are
The basic principle of regular investment is cheap, the money obtained from the previous sale
shown in Fig. 1, which illustates that investor can is used for purchasing more shares. If the investor
make a profit also when the buying price is the same follows the mechanism, he will avoid inappropriate
as the selling price (of course we do not reflect the withdrawals or deposits at times when markets
fees). are reaching extreme values (Markese, 2009). This
The level of regular payments is not the same technique is even more intuitively appealing than
because the regular investment is developing dollar cost averaging. As with dollar cost averaging,
according to the situation in the market in more investment units are purchased when prices
accordance with the value averaging strategy (Varga, are low. However, value averaging requires that
2011). If the market is in recession and prices are low, relatively more units be purchased as prices decline
investors buy more units depending on the selected than does dollar cost averaging since the unit
amount by which the portfolio is regularly price decline reduces the value of the portfolio.
increased. By contrast, there are fewer purchases of Furthermore, and contrary to dollar cost averaging,
shares during a bullish market (Marshall, 2000). value averaging gives a rule for selling. As the market
This method is suitable for application in more price increases, beyond what it was recently, value
volatile markets with bigger spreads in prices, since averaging may require unit sales since the growing
there is a possibility of reaching higher profits price rise increases the value of the portfolio. And, if
(Edleson, 2007). The rate of profit is highest when the market price continues to increase dramatically,
a large amount of shares are bought at a low price value averaging gives even more aggressive sell
and these shares are sold when prices are high. That signals to control the value of the portfolio to the
is why it is recommended to invest on stock markets level desired (Marshall, 2000). Marshal, Baldwin
which are characterized by higher volatility (Hallam, (1994) stated that dollar cost averaging is appealing
2013). because this method is contrary in the sense that
The biggest advantage of this method is the fact fewer shares are purchased when prices are high
that the investor buys shares in the time of a growing and more shares are purchased when prices are
market and also in the time of a bear trend. So the low, facilitating the “buy low” aspect of the ancient
risk of bad timing is eliminated, as is the impact investment adage, “buy low, sell high”. Haiwei,
of the investor’s subjective, emotional response Estes (2009) say that the investor who specifies
(Škatuĺárová, Šoba, Širůček, 2014). The risk of their investing goal which they want to achieve
timing is the biggest risk connected with a lump sum a
er the termination of saving and follow the rules
investment (the investor opens positions at a time according to the value averaging method, will, with
of high prices). Kohout (2013), quoting a study by very high probability, reach the goal.
Ibboston Associates, mentioned that one dollar Edleson (2007) compared the value averaging
invested in the year 1925 grew during 70 years to and dollar cost averaging investment method from
the value of value 1,114 dollars. But if the investor the point of reached profit and stated that value
had missed the 35 best months from all 840 months, averaging brings to the investor higher profit than
his profit would have been just tenfold, meaning dollar cost on a short term investment period
that 99% of profits take place during just 4% of (5 years) and also on a long term investment period
investment time. On the other hand transaction fees (20 years).
grow with higher frequency of trading by regular Hayley (2010), who compared the dollar and value
investment compared with a lump sum investment. averaging investment method with the Monte Carlo
simulation said that dollar and value averaging

II: Comparison of DCA and VA

Average annual return
5-year investment 20-year investment
dollar cost averaging 14.82% 14.31%
value averaging 16.22% 15.59%
Source: Edleson (2007)
2154 Martin Širůček, Ivana Škatuĺárová

2: Total cost and value by dollar cost and value averaging

Source: Edleson (2007)

always achieve lower average purchase costs method because there is the same payment in every
than the equal share amount strategy (and value investing period (Marshall, 2000).
averaging always achieves a greater cost reduction
than dollar cost averaging because of its more
MATERIALS AND METHODS
aggressive response to share price movements).
Both the regular investment method can be also The aim of this paper is to make recommendations
compared from the point of total cost and total to investors who use the value averaging method
value. Fig. 2 shows the cumulative amount of money for making regular investments on the US stock
invested, and the value of the total portfolio, at each market. Empirical analysis and the comparison of
point in time for the given strategy over a five-year the quantified profit rate and risk level of regular
period. The amount of money put into dollar cost investments using the value averaging method with
averaging goes up smoothly by the fixed amount. different lengths of investment horizon according to
The resulting shares increase in values as they predefined methodological criteria will be used as
accumulate and as the price level of the market a basis for suggested recommendations.
rises. On the other hand value averaging does much This empirical research of the value averaging
the opposite in that we force the value of the shares method makes use of real data from the US stock
to go up smoothly by the fixed amount. The total market, represented by the S & P 500 Index, which
amount of money invested in value averaging varies can be regarded as a barometer of the American
randomly, going up when market is down, and going economy. At the beginning of each investment
down when the market increases to dictate the sale period the investment goal was set. According to
of shares. the goal we determined the compounding value
The fact that the following fixed mechanism of each month on USD 1,000. So the value of each
minimizes the risk of bad timing is one of the greatest investment should grow each month for USD 1,0001.
advantages which the value averaging strategy The data, which was taken from the Bloomberg
offers. Other advantages include its flexibility, since Terminal, consists of historical monthly closing
predefined parameters can be modified at any time prices in the form of total return (that is, prices
during the investment process (Edleson, 2007). including dividends) between 1990–2013. For the
Regular payments can be of different amounts; 1-year investment period (short term investment
therefore, it is not possible to set a standing order. In horizon) 168 simulations of investment were made,
addition, the risk of loss is increasing because there 228 simulations were made for the medium 5-year
is no limit for regular payments (Bajkowski, Markese, investment period (medium term investment
2001). A disadvantage of the value averaging horizon) and 276 investment simulations were
method is that it imposes higher requirements on made for the 10-year investment period (long term
the mathematical knowledge of investors. Another investment horizon). In the monitored period,
disadvantage is time consumption, as the market significant speculative bubbles, falls in stock prices
development has to be watched in every period. and subsequently their growth on selected markets
This is not needed by the dollar cost averaging can be observed.

1 It does not matter if the investor calculates with the compounding value USD 1,000 or USD 100. It has no impact on
the principle of the method.
 Application of the Value Averaging Investment Method on the US Stock Market 2155

III: Input variables used in the empirical part

Investment horizon (years) 1 5 10
Nominal investment goal (USD) 12,000 60,000 120,000
Initial investment (USD) 1,000 1,000 1,000
Compounding value of each month (USD) 1,000 1,000 1,000

Parameters in Tab. III are chosen for the RESULTS

application of the value averaging method. As mentioned in the methodology, the analysis
The evaluating criteria for the choice of stock of regular investment on the American market was
market and investment horizon are the revenue-risk applied by using the value averaging method at 1,
profile and probability of loss a
er termination of 5 and 10-year investing horizons. In each period,
the investment. The revenue-risk profile is the ratio the achieved revenue from the regular investment
of the average annual profit rate measured for was considered, its final value in relation to invested
each investment by the internal rate of return and amounts and its appreciation. Attention was also
average annual risk expressed by selective standard given to the level of risk and the ratio of revenue and
deviation (Vlachý, 2006). The probability of loss risk.
a
er termination of the investment is expressed Investment held for one year achieved the
as a percentage ratio of unprofitable investments following results: In Fig. 3, which compares the final
and the total number of observations. The investor portfolio value a
er one year of the investment and
with assumed risk aversion will be recommended the value of physically embedded money, we can see
a market and an investment horizon based on how the value averaging method worked in 1990–
performed calculations, where the application of the 2013 and if the embedded money was appreciated.
value averaging strategy allows investing on average The investment goal was to save the amount of USD
at the highest level of revenue-risk profile and at 12,000. It was fulfilled in 63% of cases from 276
the lowest percentage of investment termination simulations. The minimum value was reached in
and loss. November 2008 when the investor saved only USD
The Sharpe Ratio, the most frequently used 10,003 because of the fall in stock prices towards
measurement of mutual fund investement, is the end of the investment period, which caused
also used as a criterion to help investors find an the low value of the portfolio in the last month
acceptable investment in a given investment period. and its sale for a low price. The investment was
The Sharpe index examines the performance of terminated a year later in April 2009 when it reached
an investment by adjusting for its risk. Sharpe the maximum value of USD 13,918 because prices
(1966) introduced a measure for the performance were low at the beginning of the investment period
of investment and proposed the term reward-to- and gradually increasing during the year.
variability ratio to describe it. If the investment goal was fulfilled or not, or
(rA  rFR ) if the investment was terminated with profit or
SR  , loss we cannot know by only looking at the final
A
value of the investment. When we use the value
averaging strategy, the more informative value
where represents a comparison of the portfolio value at
rA ......the performance of investment, the time of termination of the investment and the
rFR .....the risk-free rate, sum of money paid in during the investing period,
A .....the standard deviation of specific investment. respectively the sum of the cost for this investment.
The considered risk-free rate of return on three- The previously mentioned investment terminated
month US treasury bills (US Government Treasury in April 2009 attained USD 13,918 but the cost was
Bills 3-Month) is 0.05%. USD 16,575, which is a maximum from the values
Risk of the regular investment is calculated as of embedded money in this monitored period. This
standard deviation in percentage points. phenomenon was caused by a rapid fall of stock
prices from April 2007 to April 2008. Whereas
1 n
 (xi  x)2 ,
n i 1
the stock shares were bought at the value of USD
2,163 in the first month, the index value in the
twel
h month was only USD 1,133. The rapid fall
where caused the portfolio value increase in the first six
n .......number of observation in each period, months since it had contained shares bought for
xi .......finding value of profit, a high price, which rapidly decreased in the second
x̄........average value of profit. six months.
An important evaluating factor is the profit rate
of the investment. Absolute level of profit or loss
of a one-year investment with the established term
of termination is in Fig. 4. A
er the slumps in 2001
2156 Martin Širůček, Ivana Škatuĺárová

17000
Valueofinvestment(USD)

15000

13000

11000

9000
2.1.1991

2.1.1993

2.1.1995

2.1.1997

2.1.1999

2.1.2001

2.1.2003

2.1.2005

2.1.2007

2.1.2009

2.1.2011

2.1.2013
Maturityofinvestment
Finalvalueofinvestment Investedamount
3: Final value of investment vs. invested capital, one-year investment period

60% 4000
3000
50%

Absoluteprofit/loss(USD)
2000
1000
40%
0
Yield(p.a.)

30% Ͳ1000
Ͳ2000
20%
Ͳ3000
Ͳ4000
10%
Ͳ5000
0% Ͳ6000

Maturityofinvestment
rateofreturn profit/loss
4: Rate of return and absolute profit/loss, one-year investment period

and 2009 when the investment had a zero revenue, The risk was compensated for by the adequate
there was always a growth period. It is caused by level of revenue. However, it is necessary to
principles of the value averaging method, which be reminded that 20% of investments were
works on the basis of purchasing at a low price and terminated with a loss; thus, a large risk existed
selling at a high price which ensures profit. that the investment would be terminated at an
In 1990–2013, the average annual profit rate of inappropriate time. To conclude, we can state that
a one-year investment was 15.62%; the deviation a one-year investment horizon is not suitable for
in revenues achieved the value of 12.96 p. p. due using the value averaging investment strategy.
to deep falls, which affected the monitored period. In the five-year investment horizon, the target
Thus the risk and revenue profile can be calculated, value of the investment was set as USD 60,000. Fig. 5
that is the profit and risk ratio which is 1.205. This shows the development of the portfolio target value
ratio tells the investor that each unit of risk borne is and expenses during the investment. Contrary
paid by 1.205 units of profit. to the one-year investments, we can see that the
If we measured the reward to variability processing of the investment is more stable and is
using the Sharpe ratio, that is if we measure the less fluctuating. This can be explained by the fact
surplus profit over the risk-free rate, the Sharpe that the one-year investment horizon does not
ratio of the one-year investment period was offer too much space for the sales of stock shares;
1.201 (the higher the Sharpe ratio, the better the moreover, it is not possible to identify major falls
investment). and increases during such a short period.
 Application of the Value Averaging Investment Method on the US Stock Market 2157

120000

90000
Valueofinvestment(USD)

60000

30000

0
3.1.1995
3.1.1996
3.1.1997
3.1.1998
3.1.1999
3.1.2000
3.1.2001
3.1.2002
3.1.2003
3.1.2004
3.1.2005
3.1.2006
3.1.2007
3.1.2008
3.1.2009
3.1.2010
3.1.2011
3.1.2012
3.1.2013
Maturityofinvestment
Finalvalueofinvestment Investedamount
5: Final value of investment vs. invested capital, five-year investment period

In the five-year investment horizon, the value terminated in the black. Equally, the value averaging
averaging method brings profit due to purchasing method was unable to overcome deep falls of
at the time of falls and selling at times of growing stocks within the dotcom bubble, which affected
prices. The money deposit curve is basically the investments terminated in 2001–2004. The
the inversion value of the local stock market method produces its worst results in a situation of
development. It is obvious that the value averaging price growth followed by a sharp fall, because the
method has not been able to overcome the falls portfolio value is sold at actual market price in the
throughout the dotcom crisis and mortgage crisis. last month. If the investment is terminated at a time
The most expensive investment was that initiated when the dotcom bubble bursts and the price is
in April 2004. Total costs, i.e. the sum of regular much lower as compared with the previous ones,
investments, were USD 87,314 a
er five years of the money accumulated in the investment period is
investing. The final value of this investment was USD depreciated and the investment can be terminated
69,593, so, as a result, the investor has lost more than with a loss (as it was in the critical years from 2001 to
a quarter of the embedded money. In 2004–2009 2004 and from 2008 to 2010).
the American stock market grew, so that the money Although the investments with the five-year
accumulated in the form of regular investments was investment horizon did not reach a revenue in the
rather high in this period. Nevertheless in the last critical years 2001–2004 and 2008–2010, compared
few months of the investment period, stock prices to the one-year investments, 84% of the investments
fell deeply and with them also the portfolio value. terminated in the black for the whole period. Fig. 6
Before January 2010, no five-year investment was illustrates the rate of revenue and absolute profit or

35% 50000
30% 40000
Absoluteprofit/loss(USD)

30000
25%
20000
Yiled(p.a.)

20% 10000
15% 0
Ͳ10000
10%
Ͳ20000
5% Ͳ30000
0% Ͳ40000
3.1.1995
3.1.1996
3.1.1997
3.1.1998
3.1.1999
3.1.2000
3.1.2001
3.1.2002
3.1.2003
3.1.2004
3.1.2005
3.1.2006
3.1.2007
3.1.2008
3.1.2009
3.1.2010
3.1.2011
3.1.2012
3.1.2013

Maturityofinvestment
rateofreturn profit/loss
6: Rate of return, absolute profit/loss, five-year investment period
2158 Martin Širůček, Ivana Škatuĺárová

loss development according to the date of maturity results gained by the testing value averaging
of the investment on the five-year investment method in the ten-year investment horizon it was
period. found that in 95% of cases the investment attained
Even though it was not possible to overcome positive indexing. However, as with the short-term
the falls and terminate the investment in the black investments, it was not possible to terminate the
while using the value averaging strategy at the time investment in the black in 2008–2009 by using this
of falls of the stock markets, the average annual rate strategy. Considering there was a big difference
of return was generally 10.95% in the monitored in stock prices in the first decade of the analysed
period. While measuring the average rate of return period, there was the possibility of achieving high
with an average risk of 9.11 p. p., the achieved profits, because it was permitted to sell the equity
revenue-risk profile was 1.202. A similar result is shares already in the portfolio. The algorithm
indicated by the Sharpe index, which was 1.196. In dispatched many signals to sell the equity shares in
conclusion, for the five-year investments, we can the portfolio, which was implemented thanks to the
say that using this method is suitable for markets active administration of the portfolio. Looking at the
with stable growth and also for markets with a high investment terminated in July 2000, we can observe
dispersion in stock prices if the investment horizon that this investment was terminated at nearly zero
is at least 5 years. costs. These costs represent the sum of regular
The target level for a ten-year investment horizon monthly payments.
was set at USD 120,000. During the analysis of

180000
160000
140000
Valueofinvestment(USD)

120000
100000
80000
60000
40000
20000
0
3.7.2000

3.7.2001

3.7.2002

3.7.2003

3.7.2004

3.7.2005

3.7.2006

3.7.2007

3.7.2008

3.7.2009

3.7.2010

3.7.2011

3.7.2012

3.7.2013

Maturityofinvestment
Finalvalueofinvestment Investedvalue
7: Final value of investment vs. invested capital, ten-year investment period7

25% 140000
120000
Absoluteprofit/loss(USD)

20% 100000
80000
15% 60000
Yield(p.a.)

40000
10% 20000
0
5% Ͳ20000
Ͳ40000
0% Ͳ60000

Maturityofinvestment
rateofreturn profit/loss
8: Rate of return, ten-year investment period
 Application of the Value Averaging Investment Method on the US Stock Market 2159

Since many sales of shares were effectuated in November 2008 to July 2009 were not profitable.
this period, especially in its second half, which had Compared to the previous investment horizons,
been purchased at very low prices at the beginning the ten-year investments were more profitable.
of the investment period, the investor accumulated Considering the revenue, a minimum ten-year
some extra profits to the portfolio due to more sales investment horizon can be recommended. Fig. 8
of shares. In this case, there is an obvious difference illustrates the development of the rate of revenue,
compared to classic saving where a certain amount respectively the absolute profit or loss. The ten-year
is embedded in the market every month and spent investment period had the lowest average profit
on shares of an asset. In this particular investment of investment, only 7.53% p.a., in comparison with
(from July 1990 to July 2000), there were 40% of the short term and medium term.But on the other
cases when the investor sold the shares – thus hand, the standard deviation or the risk was also
gaining other funds and only 60% of months when lowest at 4.51 p.p. The risk-revenue profile was then
he purchased (saved). Therefore, we can claim calculated as 1.669, which was the best result. This
that with the increasing length of the investment means that the investor must always compare not
horizon, there is a higher probability of the equity just the profit of each investment, but also include
shares sell-off. the calculation of the risk. The same result was
It was possible to achieve the highest rate of return shown by the Sharpe ratio, which was also the best
at the level of 20.7% with the investment terminated of each investment, namely 1.658.
in August 2000. By contrast, the investments from

DISCUSSION AND CONCLUSION

Tab. IV presents a final evaluation of the value averaging method on the American market for 1, 5
and 10-year investment horizons in view of an average revenue, risk and revenue-risk profile
of the investment. To conclude, it can be advised to choose at least a ten-year investment horizon.
The revenue-risk profile of the ten-year investment reached 1.67, i.e. the average revenue
from the investment was higher than the average risk, which was compensated by the revenue.
The level of the revenue-risk profile by five-year and one-year investments represents a compensation
of the risk by the revenue; nevertheless, there is a risk of bad timing of the investment in these cases,
because the value averaging method was not able to overcome the falls surrounding the dotcom crisis
and the recent mortgage crisis. In the ten-year investment, the final value of the portfolio exceeded
the embedded money in 95% of cases, the investment in the five-year investment horizon reached
positive indexing in 84% of cases.

IV: Investment parameters and results

Investment period
1 year 5 years 10 years
Average yield (% p.a.) 15.62 10.95 7.53
Average risk (p. p.) per year 12.96 9.11 4.51
Revenue-risk ratio 1.205 1.202 1.669
Sharpe ratio 1.201 1.196 1.658

In the table we can observe a decreasing trend in the values of average annual return and average
annual risk. If we consider a very short investment period, in this case the one-year investment
period, there is no space for fluctuations in share prices and the trend is mostly only increasing or
only decreasing. Thus, it is equally possible to achieve high profits or high losses. That is why it can
be noticed that there is a significant volatility in revenues for the one-year investment horizon, which
has not been compensated by additional profit. On the contrary, it was possible to identify falls and
growths within one investment for a long-term investment horizon, which can be profitable for
the tested investment strategy. For this reason, the profits were not very significant; nevertheless,
dramatic losses did not occur either. This is why we can see a more stable development of revenue
and risk for the long-term investment.
The obtained results are in compliace with Edleson (2007), who also comes with results that the longer
the period, the lower the profit, but also the lower the volatility and that the ratio between profit and
risk (standard deviation) is higher (best) in the long term investment period (in his case, a 20-year
investment period).
The investor should always compare the relationship between risk and profit. So that he can recognise
which investment has the best risk and profit ratio, that is which investment brings him the biggest
reward for the smallest risk.
2160 Martin Širůček, Ivana Škatuĺárová

The obtained results have some limitations. First of all it is necesary to say that these results cannot
be generalized, because on another market, in another time period, for example, a short investment
period can bring better results. Also if the market embodies short but stable rising, e.g. linear
growth with low volatility (level of risk, standard deviation), the investor can obtain high profit with
low risk and the results can be otherwise. On the other hand if we focused on stock market where
the recommended investment period is more than 5 or 7 years, the results of the revenue-risk ratio
confirm the longer period as the better risk-profit profile. The same is confirmed by the Sharpe ratio,
where the asset profit was just adjusted of risk-free rate and compared with the risk of the asset.
The best ratio between profit and risk (1.669) is in the longest investment period, where each unit of
additional risk brings the investor 0.669 units of profit. The best Sharpe ratio was also with the long-
term investment horizon, namely 1.658, where each additional unit of risk brings the investor an
additional 0.658 unit of profit investment above the adjusted risk-free rate of return.

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Contact information
Martin Širůček: martin.sirucek@mendelu.cz