HOW DOES THE CONSTANT-RATIO PLAN WORK?

As in the constant-dollar plan, in a constant-ratio plan the investor divides his or her investment portfolio into two parts: a speculative portion and a more conservative portion.  But instead of a constant-dollar amount, the investor establishes a constant ratio between the speculative and conservative portions of the portfolio.  When the ratio between the two sides differs very much from the desired ratio, the investor rebalances his or her portfolio.

When the speculative part of the portfolio falls below the set ratio, funds are added to it from the conservative portion.  When the speculative securities rise in value, some are sold and the proceeds are reallocated to increase the value of the conservative portion.

For example, suppose an investor wishes to keep 10 percent of his $10,000 portfolio in stock XYZ.  Currently, that means he has $1,000 worth of stock XYZ.  But what happens if the value of the portfolio as a whole rises to $20,000?  The investor now adjusts his shares of stock XYZ to a value of $2,000, or 10 percent of $20,000.

Why do investors use formula investment plans?