Formula Investment Plans

Formula investment plans are long-term investment strategies based on a fixed formula of adding dollars to investments, applied over time and without using security analysis or market timing. These investment plans are especially useful for those who earn a steady income. There are many formula plans, or variations of them, but the most common formula plans are:

Dollar-Cost Averaging

Dollar-cost averaging is a passive investment plan that invests a constant dollar amount per unit of time, such as a month, taking advantage of the natural fluctuations of market prices over time. This technique can be used for specific securities or for securities covering a larger swath of the market, such as exchange-traded funds or mutual funds. With dollar-cost averaging, more shares are bought at a lower price, when the market is down, than at a higher price, when the market is up.

Dollar-cost averaging can be combined with dividend reinvestment plans (DRIPs), offered by many blue-chip companies, where the investor can buy company stock directly from the company, free of transaction costs. There are no transaction penalties for buying less than a round lot of shares (100 shares) and can even be purchased in fractional amounts. Furthermore, all the dividends can be reinvested automatically if the investor desires. With DRIPs, all the money is invested in the stock, whereas in buying securities in the market, there may be some transaction costs, and may be higher for odd lots (less than 100 shares); and since only whole shares can be purchased, there will be some money left over, unless the share price happened to be an exact multiple of the constant dollar amount allotted by the investor. The main disadvantage of DRIPs is the lack of diversification, since almost all DRIPs are offered by blue-chip companies.

Constant-Dollar Plan

The constant-dollar plan, sometimes used synonymously for dollar-cost averaging, consists of 2 portions: speculative securities to hopefully earn substantial capital gains, and conservative investments, such as a bonds, Treasuries, or savings to earn interest while protecting the principal. A constant-dollar range is delimited by triggers applied to the speculative portion of the portfolio, so that if the speculative portion falls outside of the range, the portfolio is rebalanced to bring the speculative portion back to its original amount. If the speculative portion rises above a certain dollar amount, enough of the speculative portion is sold to bring it back to the original dollar amount, with the proceeds of the sale transferred to the conservative portion of the portfolio. If the speculative portion falls below the range, then money is taken out of the conservative portion to buy more speculative securities.

Constant-Ratio Plan

The constant-ratio plan follows the constant-dollar plan in that they both consist of a speculative portion for greater capital gains and a conservative portion for lesser risk, but the constant-ratio plan maintains a specific ratio of speculative to conservative securities. When the proportion deviates by a certain percentage, then securities are sold out of the larger portion to buy more securities in the smaller portion, thereby maintaining the desired ratio.

Variable-Ratio Plan

The variable-ratio plan uses a variable proportion of risky investments to safer investments, such that when the prices of the risky securities are low, more money is invested in them, but when they are high, they are sold, placing the proceeds in conservative investments. This obviously involves some market timing, but it takes advantage of the cycles of low and high values that risky assets continually pass through. This is particularly true of futures and commodities, because if their prices veer too low or too high, economic forces, primarily changes in supply and demand, will restrain their prices from becoming too extreme.

In a simple variation of this plan, when the value of the speculative portion of the portfolio reaches a certain percentage, enough speculative securities are sold to reduce the speculative portion down to a lower percentage of the portfolio. For instance, if the speculative portion reaches 70% of the total portfolio value, then enough speculative securities are sold to reduce the speculative portion to 30%, with the proceeds of the sale going to conservative investments. When prices of the speculative securities drop, then more speculative securities are bought at the lower prices, to, hopefully, ride the cycle back up to higher prices.


The success of these plans will depend on the plan details and the investment horizon, where greater success is more likely with a longer investment horizon, especially for a portfolio of risky assets.