Value Averaging Plan Sells Profit

Yesterday, The Kelly Letter’s limit order to sell part of its small cap stock ETF filled at precisely the price we specified.

This was part of our Tier 1 plan, which is a value averaging strategy that sells performance in excess of a 3% quarterly growth target. Because the ETF gained more than 3% last quarter, we automatically sold the surplus. One day, when it gains less than 3% or posts a quarterly loss, we’ll use the proceeds from quarterly sales like yesterday’s to buy more shares at the cheaper price to get the plan back on its 3% growth track.

Yesterday marked our fourth quarterly sale in a row. The last time the plan bought to compensate for underperformance was a year ago, after the rough first quarter prior to the rocket higher. Small company stocks, as exemplified by the ETF we use, have grown at a rate faster than 3% per quarter for a year now.

What does this mean for market timers? Beats me. The strategy doesn’t try to guess and doesn’t care. If small cap stocks keep growing at a rate faster than 3% per quarter, the plan will keep selling the surpluses all the way up and that will have been the wrong move. Buying and holding would have been smarter because each quarterly sale would have removed capital from the rising line.

However, even years later the plan can justify itself. That’s what happened in the bull run from the dot com bubble collapse to the housing bubble collapse. The market kept rising and the plan either stood pat on the 3% growth line or sold strength. When it all came tumbling down again, those once seemingly “dumb” quarterly sales looked brilliant when they provided the cash to buy into the extreme weakness of 2008 and early 2009 to not only keep the plan on track, but profit handsomely during the last year of levitation.

The whole beauty of the plan is that we don’t have to think about whether it’s getting the timing right or wrong. We just have to follow it, secure in the knowledge that come hot or cold weather our Tier 1 will keep growing at 3% every quarter.

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