Constant Proportions Investing

When it comes to investing, simplicity is perfection. While it is impossible, we continue to search to implement the perfect strategy at every point in time. But the perfect strategy is actually extremely simple. But perfect in process not outcome.  

The best way to do this is by using a method called constant proportions investing. Simply put, whenever you invest, you keep the same proportions of funds invested in stocks and the remainder in cash (or other asset classes such as bonds or gold for example).

Choosing an 80/20% strategy with a starting amount of $10,000 means starting with $8,000 in stocks and $2,000 in cash.

Whatever time period you choose, whether weekly, monthly, quarterly or annually, you rebalance back to those original starting proportions (80/20).

For example, if your stocks went from $8,000 to $9,000 and assuming cash stayed constant, you would add $9,000+$2,000=$11,000. Now multiple $11,000 by 0.8 and you have the amount that should be in stocks. So the new arrangement is $8,800 in stocks and $2,200 in cash. 

With your current stock value at $9,000, you need to sell $200 worth of stock and add it to the cash pile. At the next chosen rebalance point, you do exactly the same thing. If stocks fall in value then you will be required to buy some stocks. 

This strategy is proven to outperform a buy and hold strategy over the long run and perhaps counterintuitively you build wealth more quickly. That’s because of the maths of volatility. 

If you have additional funds you can simply add them in the same proportion. So simply add another $100 and then do the same calculation.

That’s how simple investing can be. You can choose any starting proportions you prefer, and we often do using the CAPE as a valuation metric. That’s why we allocate more to stocks when the CAPE is low and less when it is high. But we never use 10 percent of the funds when starting out.

With constant proportions, we get to understand why investing with a CAPE of 10 is different to a CAPE of 35. 

Many investors don’t rebalance properly and after a good run they often take too little of their portfolio and suffer large losses in the down cycles. Or they don't add enough when stocks fall. 

This way is a simple peace of mind approach that does all the hard work for you.