The 3% Signal- A solid core investment strategy

Due to the severe subprime mortgage crisis I have some understanding for the scepticism surrounding the stock market. However, in a time of increasing national debt and aging population it is more important than ever for people to take control of their finances as early as possible. Thanks to the magic of compounding an early start can make a drastic difference.

To give you an idea on what your end goal should be let me introduce you to the concept of Safe Withdrawal Rate (SWR) which stands at 4%. To get an idea of how much you need to retire, time your annual spending by 25. That sum invested in a safe fund should give you a 7% annual return, subtract a 3% average inflation rate and this leaves you with a safe withdrawal rate of 4% which you can use for your retirement.

In this post I would like to explain the simple yet powerful investment approach — Value Averaging described by Jason Kelly in his book The 3% Signal. Despite the book being a rather convoluted I found the concept to be compelling. Before diving in let me summarize its intent concisely:

The 3% signal offers a simple arithmetic framework to buy low and sell high aiming for an annual growth rate of 12% by committing 10 minutes of your time every quarter.

So, taking a hypothetical initial investment of 10,000$ we’ll start by splitting our money in a 80/20 fashion. When either of these reaches 10% above or below this target we’ll rebalance accordingly on our quarterly check. Both of these sums will go into an exchange traded fund (ETF). If you’re unfamiliar with these then you can read more about it here. They are basically a passive fund which tracks a given index — a group of companies. Although The 3% Signal could be done on any equity, by investing in many companies through one ETF it is practically impossible to lose all your money. If that was the case we’d have more to worry about, an apocalypse perhaps!?

1. Which funds?

Before I explain the strategy let’s first clarify the allocation:

Our 8,000$ will go in the iShares Core S&P Small-Cap (IJR) which as the name suggests tracks the small-capitalization U.S. equities with a tiny 0.07% expense ratio!

Why IJR you may ask? America has a solid growth history of nearly a century which remains unmatched. We choose the S&P which is viewed as one of the best indicators, it is also market-cap weighted which is more meaningful than a price-weighted index. Lastly, looking at the graph below you may think IVV is an equally good choice but this strategy benefits from the high volatility which IJR offers.

  • iShares Core S&P Small-Cap (IJR)
  • iShares Core S&P Mid-Cap (IJS)
  • iShares Core S&P 500 (IVV)

Our remaining 2,000$ will go into a bond fund, on the left is a table of viable options put together by Jason and on the left I’ve put them together in a single 10 year chart for comparison.

We want this portion of our money to be very safe, thus we accept a lower growth target 2–4%. Jason settles for VFIIX which wasn’t available through my broker so I chose BLV with a higher volatility but higher return.

2. So, what’s the strategy?

I said that we’ll achieve a minimum of 12% annual growth, if we split that into quarters then we can set ourselves a quarterly growth target of 3% which we assign to the growth section of our portfolio (IJR). This goal isn’t completely arbitrary, if we consider the 1928 to 2016 arithmetic average growth to be 11.42% then this goal makes sense.

Every quarter you’ll evaluate the growth of IJR, if it falls below 3% then you’ll want to transfer the difference from VFIIX into IJR (Buy Signal). If the growth is higher then you’ll want to do the opposite (Sell Signal). It’s that simple!

Your monthly savings should automatically go into BND on a monthly basis. If BND reaches 10% above its 20% total allocation (VFIIX+BLV) then you’ll want to rebalance accordingly at the next quarter evaluation.

Jason backtested this technique, in 2008 for example when the market crashed in excess of 30% there wasn’t sufficient funds in VFIIX to fulfill BLV growth. This is normal and a great opportunity for the investor to commit external funds should there be any available. It is encouraged to have a bottom-buying account for this purpose.

We also enter a mode he calls “30 down, stick around” which means we’ll ignore the next four sell signals in order to remain fully invested in the market recovery.

Here’s a table which illustrates the performance of various plans. Ignore Garrett and Selma, they are fictional characters made by Jason in order to explain negative typical investor behaviours. Mark however is the individual who follows 3Sig to the letter, also making a monthly contribution from his salary.

You can find a purpose built spreadsheet for this plan here.

I think Jason has put together a solid strategy which offer great rewards given how little time is required. It offers simple instructions, by issuing buy or sell signal in harmony with the condition of the market. Further, is pays no attention to the analysts and economists who are only right 50% of the time, he refers to this as the zero-validity environment.

If you’re like me who likes to take a more proactive stance towards investing then as the title suggest this would make for a great core strategy, to which you can allocate ±80% of your savings. The rest can target more speculative, high reward & risk equities. As covered by Peter Lynch in his book One Up On Wall Street there are fantastic opportunities to be found in companies we are exposed to as consumers.

I’d love to hear more about your thoughts & investment ideas in the comments below. Let me know if anything isn’t clear, I’m happy to elaborate.

DISCLAIMER: The above references an opinion and is for informational purposes only. I make no representations as to accuracy, completeness, suitability, or validity, of any information. I will not be liable for any errors, omissions, or any losses, injuries, or damages arising from its display or use. All information is provided AS IS with no warranties, and confers no rights.