Value Averaging for 401(k) Plans Hakes More 'Cents' than Dollar-Cost Averaging

Chen, Haiwei; Estes, Jim
February 2007
Journal of Financial Planning;Feb2007, Vol. 20 Issue 2, p56
Academic Journal
Executive Summary. • Does it make more "cents" for the average 401 (k) investor without a huge reserve of capital to dollar-cost average or to value average? Financial planning literature has not answered this question because previous studies assume that any investment shortfall under value averaging can be filled. Yet value averaging is not self-sustaining because the average investor lacks the requisite capital reserves. • This study develops a feasible value-averaging strategy for average 401 (k) investors by using the equity mutual funds as the driving force and the monthly 401 (k) contributions and the bond account as the natural capital reserve. This feasible approach is called 401 (k) value averaging. • Using monthly historical return data, simulations show that the 401 (k) value-averaging strategy generates a higher terminal value for the 401 (k) retirement portfolio than traditional dollar-cost averaging. Based on the total risk and risk/reward comparisons such as the Sharpe ratio and the Sortino ratio, it is optimal to follow the 401 (k) value-averaging strategy with a target annual growth rate between 8 percent and 12 percent.


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