# What is rules-based asset allocation?

> Why investors write allocation rules down, the four common kinds of rule, and what rules can’t do.

Many people who invest on their own pick a mix, such as 60% stocks and 40%
bonds, and hold it. A rules-based strategy changes the mix when conditions
change, following rules written down in advance.

## Why write the rules down

- **You decide once, calmly.** The rule is set before a crash, not in the
  middle of one.
- **You can test it.** A written rule can be replayed on history before you
  trust it with money.
- **You can see why.** At any moment you can tell exactly why the strategy holds
  what it holds.

## Four common kinds of rule

The four starter patterns in the builder are simple examples of each.

- **Trend following** holds growth assets while their price is above a long
  average and steps aside when it falls below. It aims to miss the worst of long
  declines. The price is whipsaw: selling after a dip and buying back higher when
  the trend resumes. A classic example is
  [Faber's 10-month moving average](https://tactfolio.com/strategies/faber-10-month-moving-average.md).
- **Buying dips** adds to an asset after a short, sharp fall, betting on a
  bounce. It works in steady markets and hurts when a fall keeps going.
- **Momentum rotation** regularly switches into whatever did best recently. It
  rides long runs and loses when leadership flips quickly. A classic example is
  Antonacci's [Dual Momentum](https://tactfolio.com/strategies/dual-momentum.md).
- **A fixed mix** keeps set proportions and rebalances back to them. It makes no
  prediction at all; rebalancing simply sells some of what rose and buys some of
  what fell. Classic examples are the [60/40 portfolio](https://tactfolio.com/strategies/60-40-portfolio.md)
  and the [Permanent Portfolio](https://tactfolio.com/strategies/permanent-portfolio.md).

## How often to check

How often a strategy runs decides how often its rules are checked. Daily rules
react fastest but trade more, and every trade costs something. Monthly or
quarterly rules trade less and react more slowly. Neither is right in general;
test both.

## One rule in plain words

The Trend following pattern reads like this:

1. If QQQ is above its 200-day moving average, hold SPY and QQQ, sized so each
   carries a similar amount of risk.
2. Otherwise, if QQQ's 10-day RSI is below 30, which signals a sharp short-term
   fall, hold QQQ.
3. Otherwise, hold gold (GLD) and US Treasury bonds (IEF).

It checks these rules every trading day. In the [builder](https://tactfolio.com/builder), the same
rules are this tree:

Strategy "Trend following", which runs daily and rebalances every run:

- Weight: Equal
  - If: current price of QQQ is above 200d moving average of QQQ
    - Then:
      - Weight: Inverse vol 63d
        - **SPY**
        - **QQQ**
    - Otherwise:
      - Weight: Equal
        - If: 10d RSI of QQQ is below 30
          - Then:
            - Weight: Equal
              - **QQQ**
          - Otherwise:
            - Weight: Inverse vol 63d
              - **GLD**
              - **IEF**

## What rules can't do

A rule only knows what it was told to look at. It can't foresee news, it will
act on false alarms, and it will sometimes trail simply holding. The question is
whether you can live with its bad stretches, which is what a
[backtest](https://tactfolio.com/docs/concepts/reading-a-backtest.md) helps you judge.

## Learn the ideas behind it

- [Tactical asset allocation](https://tactfolio.com/learn/tactical-asset-allocation.md): What tactical asset allocation is, how it differs from strategic allocation, and what Faber's model did in 2008 and after, with dated backtest figures.
- [Portfolio rebalancing](https://tactfolio.com/learn/portfolio-rebalancing.md): What portfolio rebalancing is, why a 60/40 mix drifts, calendar vs threshold methods, and how taxes and costs fit in.
- [Risk parity](https://tactfolio.com/learn/risk-parity.md): Risk parity balances risk instead of dollars. See a simple stock and bond example, why funds use leverage, and what went wrong in 2022.