The investor will make a beginning investment in the risky asset equal to the value of:
(Multiplier) x (cushion value in dollars)
and will invest the remainder in the riskless asset.As the portfolio value changes over time, the investor will rebalance according to the same strategy.
Consider a hypothetical portfolio of $100,000, of which the investor decides $90,000 is the absolute floor. If the portfolio falls to $90,000 in value, the investor would move all assets to cash to preserve capital.
The value of the multiplier is based on the investor's risk profile, and is typically derived by first asking what the maximum one-day loss could be on the risky investment. The multiplier will be the inverse of that percentage. So, if one decides that 20% is the maximum "crash" possibility, the multiplier value will be (1/.20), or 5. Multiplier values between 3 and 6 are very common.
Based on the information provided, the investor would allocate 5 x ($100,000 - $90,000) or $50,000 to the risky asset, with the remainder going into cash or a riskless asset.
The timetable for rebalancing is up to the investor, with monthly or quarterly being oft-cited examples. Ideally, the cushion value will grow over time, allowing for more money to flow into the risky asset. If, however, the cushion drops, the investor may need to sell a portion of the risky asset in order to keep the asset allocation targets intact.