Constant ratio plans are examples of an investing approach that defines the contents of a portfolio based on asset classification. Essentially, the constant ratio plan seeks to establish a balance between the types or classes of investments that are maintained as part of the investor’s holdings. The purpose of this kind of investment strategy is to make it possible to stabilize the value of the portfolio by moving money between the assets so that a minimum overall worth is maintained, regardless of the performance of the individual securities.
In a sense, the constant ratio plan is somewhat like applying the principle of a scale. When items on each side of the scale are more or less equal, the scale is understood to be even. The same is true with a constant ratio plan. When all the securities are maintained at a certain value per class or type of security, the portfolio is balanced and considered to be even or level in nature. If one security begins to underperform, this throws the portfolio out of balance, and requires a redistribution in order to regain an equitable level of allocation per security.
Generally, the constant ratio plan calls for being able to utilize the same securities to restore balance when one or more securities go through a slump. This is accomplished by moving money associated with other securities in the portfolio over to cover the losses generated by the underperforming securities. Just enough is moved to restore the balance, and help to cover the downward trend until it is clear whether or not the security will recover and begin to rise again.
Using this sort of asset allocation is a popular way of holding on to shares of stock that the investor considers highly desirable. If the suspicion is that a given security will recover and begin to perform after a period of time, a constant ratio plan minimizes the overall loss and allows the investor to justify hanging on to the security in the interim. This approach is often employed with long established stocks that go through a slump, but are expected to recover, even if the recovery time is considered long term.
