From this point on, all the formulas treated in this book deal with an established fund, rather than with a constant flow of new money to invest, as in the case of dollar averaging. However, just as dollar averaging can be adapted to the requirements of a fixed sum, so can most of these other plans be used in managing a fund, which is constantly being added to. These techniques are all broadly classified as “ratio” formulas.

The Ratio Principle

Like dollar averaging, ratio plans are aimed at combating the danger of losses due to unforeseen fluctuations in the stock market. Ratio plans are all alike in that they are concerned solely with the proportion of the investor’s capital which is held in stocks as against that used to purchase bonds. The percentage of stocks is intended to be increased when the market is low, and decreased when it is high. The idea is to reduce the amount of risk securities held when prices are high, and conversely to purchase stocks at what are presumed to be bargain levels when the market is low.

A couple of comments are in order concerning the practicability of these formulas for the average investor. First, it is hardly realistic to talk about techniques which involve the sale of a few hundred, or even a few thousand, dollars’ worth of stocks in order to replace them with bonds. Most small investors (and a great many large investors) have neither sufficient knowledge of the bond market nor sufficient capital to make buying bonds a practical matter. For most investors, therefore, an indication to sell a certain amount of stocks and buy bonds with the proceeds can most effectively be interpreted as a direction to withdraw the specified amount of money from the stock market and divert it to a savings account or an account with a savings and loan association, or hold it in cash. Stocks - Read More.