Asset allocation: why a rule like cash 30, stocks 70 helps

Most losses individual investors take come not from picking the wrong stock but from putting too much in at once. Asset allocation is the rule that decides how much before deciding which stock.

What cash does

Holding 30% in cash looks like a drag on returns, but it does three jobs. It lets you buy in a crash. It keeps one bad stock from taking down the whole account. Most of all, it makes you less impatient. Without cash, every decision turns into "should I sell now?"

How to set weights

• Regime: raise the stock weight when the index is in a major uptrend, and raise cash when it is in a major downtrend. How regime is judged is on the methodology page.
• Cap per stock: keep any single stock under 20% of the total. The more convinced you are, the more you need this rule.
• Loss tolerance: size the position so that hitting the stop costs no more than 1 to 2% of total assets. The distance between entry and stop sets the quantity.

Rebalancing

Assets that rose take up more of the portfolio, and assets that fell take up less. If you restore the original weights on a fixed schedule (quarterly or every six months) or when a weight drifts by a fixed amount (10 percentage points or more from target), you end up selling a little of what rose and buying a little of what fell. It is the most mechanical way to sell high and buy low without emotion.

Caution

30 to 70 is an example, not the answer. It depends on your age, income, other assets and how much swing you can stand. What matters is not the number but deciding in advance and sticking to it.