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Title: The 3% Signal
Author: Jason Kelly
Date of Publication: February 24, 2015
Retail Price: $16 US (Trade Paper)
Take the stress out of investing with this revolutionary new strategy from the author of The Neatest Little Guide to Stock Market Investing, now in its fifth edition
In today’s troubling economic times, the quality of our retirement depends upon our own portfolio management. But for most of us, investing can be stressful and confusing, especially when supposedly expert predictions fail. Enter The 3% Signal. Simple and effective, Kelly’s plan can be applied to any type of account, including 401(k)s — and requires only fifteen minutes of strategizing per quarter. No stress. No noise. No confusion.
By targeting three percent growth and adjusting holdings to meet that goal, even novice investors can level the financial playing field and ensure a secure retirement free from the stress of noisy advice that doesn’t work. The plan’s simple technique cuts through the folly of human emotion by reacting intelligently to price changes and automatically buying low and selling high. Relayed in the same easy-to-understand language that has made The Neatest Little Guide to Stock Market Investing such a staple in the investing community, The 3% Signal is sure to become your most trusted guide to investing success.
One day long ago, I found my mother sitting befuddled behind a stack of stock market ideas.
A simple quarterly system that beats the stock market.
The antidote to low 401(k) performance and high stock market stress.
3Sig: Shorthand for “The 3% Signal,” both the book’s title and the technique it describes.
Z-val: Shorthand introduced in The 3% Signal for “zero-validity forecasters” and “zero-validity environment.” The latter phrase was coined by Nobel Prize winner Daniel Kahneman in his book Thinking, Fast and Slow, where he wrote that “stock pickers and political scientists who make long-term forecasts operate in a zero-validity environment. Their failures reflect the basic unpredictability of the events that they try to forecast.” This is why stock market forecasters are proven to sport an accuracy rate of about 50 percent, same as a coin toss … yet they continue forecasting.
“You’ll discover how to check in quarterly to see whether the stock fund’s growth is below target, on target, or above target, then move money in the appropriate direction between the stock fund and the bond fund. This action, using the unperturbed clarity of prices alone, automates the investment masterstroke of buying low and selling high — with no z-val interference of any kind.”
“What the experts don’t want you to know — but what you’ll never forget after reading this book — is that prices are all that matter. Ideas count for nothing; opinions are distractions. The only thing that matters is the price of an investment and whether it’s below a level indicating a good time to buy or above a level indicating a good time to sell. We can know that level and monitor prices on our own, no experts required, and react appropriately to what prices and the level tell us. Even better, we can automate the reaction because it’s purely mathematical.”
“The stock market is humanity’s monkey mind writ large. For many, there is no greater cacophony, no greater distraction from life than the news cycle connected to financial markets. The more enlightened way to navigate the market is by letting it all go, reducing the chaos to a concise list of prices, visiting that list just four times a year, letting an unemotional formula tell you what the prices mean you should do, and then doing it. This higher state of investing not only performs better, it costs less and uses less of your limited time on Earth.”
We often hear, and have come to believe, that models beat experts. Kelly offers the individual investor a simple, mechanical model that instills discipline, removes a lot of self-sabotaging emotion, and has a good track record. Will it continue to outperform? Actually, it just might.
— Brenda Jubin, “Reading The Markets” book review at Investing.com and ValueWalk
If you’re a producer or host, you’ve probably experienced these:
Guests who don’t show up or call at the designated time
Guests who don’t know their subject
Guests who give five-word answers that leave you hanging
Guests who are boring
For your show, you want a guest who knows his subject and can talk about it in a way that’s interesting to your audience. That’s me. I’m good at explaining concepts to beginners, but in a way that makes more experienced listeners nod with joy at hearing somebody put the subject in understandable terms.
I speak in a conversational, humorous tone with a bright personality. Audiences say they enjoy listening to me. Isn’t that the kind of guest you want?
Most producers and hosts who’ve worked with me are eager to do so again. I’m prompt, professional, and good at keeping the conversation flowing. No curt, where-to-from-here kinds of answers from me.
I’d love to join your show, either in-person or by phone. Let’s book something!
Short (36 words):
Jason Kelly writes about the stock market and runs the 3 percent signal plan in The Kelly Letter, which goes out to subscribers every Sunday morning. He lives in Japan. Visit his website at jasonkelly.com.
Medium (208 words):
Jason Kelly graduated in 1993 from the University of Colorado at Boulder with a bachelor of arts in English. He worked for several years at IBM’s Silicon Valley Laboratory, where he wrote articles and books that won him the Society for Technical Communications Merit Award. He moved from writing about computers to writing about finance, and found his niche in the stock market. Having realized his dream of being able to live and work anywhere in the world, Jason moved to Japan in 2002 and works from his office in the countryside about two hours from Tokyo.
After the March 2011 earthquake and tsunami, he founded Socks for Japan, a volunteer organization that hand-delivered 160,000 care packages from around the world to survivors. More than 70 percent of donations came from the United States. In that moment of crisis, seeing return labels from churches, Brownie troops, neighborhood coffee shops, small town light and power departments, Mrs. Wilson’s fourth grade class, and other mainstays of American culture filled him with pride for his country.
He keeps busy writing new books and The Kelly Letter, and exploring Japan. With his sister and business partner, Emily, he co-owns Red Frog Coffee in Longmont, Colorado. Visit his website at jasonkelly.com.
Long (464 words):
Please see the About page.
With your bestselling book The Neatest Little Guide to Stock Market Investing, and popular newsletter The Kelly Letter, you’ve been offering stock market investing advice for over twenty years. You began as a technical writer at IBM in California, with a background in writing. How did you get involved in investing?
That job at IBM’s Silicon Valley Lab started everything. My editor at IBM, Fred Bethke, was superb. He taught me how to write about complex topics in a way that was interesting for readers. Even books on potentially dry subjects, such as mainframe software installation, needed to engage readers and surprise them with wit, fun examples, and other unexpected moments of levity in what they thought would be just a workday slog. If the writing didn’t do this, it didn’t get past Fred. We all learned quickly how to do it right, how to do it consistently, and how to stay on Fred’s good side. We won awards for our work.
I realized after a couple of years in Fred’s technical writing bootcamp that other topics could benefit from the approach. I’d studied investing on my own in college, and decided to write a friendly manual covering the basics to give away as a Christmas present to family members that year, mainly my mom. Before I knew it, photocopies had been distributed widely and I was receiving emails from people I’d never met asking about the book. Somebody suggested I get it published for real, and that book became the first one I published, The Neatest Little Guide to Mutual Fund Investing.
I loved investing, and kept at it. I grew my own account through experimentation, using myself to test most of what I wrote about. I discovered that there’s not as much to successful investing as the industry would have people believe. Conveying the core truths of the business has remained my motivation while writing my Neatest Little Guide series, The Kelly Letter, and most recently The 3% Signal.
Tell us about your research.
Most of it has involved reading academic studies and testing what I’ve found in them. The problem with a lot of academic findings is that they’re impractical for an individual investor managing a portfolio. Anything that is based on holding more than about 20 stocks is a waste of time, because almost nobody can manage that many positions without reverting to index returns or worse, in which case they should just own an index, which is the market as a whole via the S&P 500, for instance. Most pros lose to indexes, and part-timers tend to do a little worse because their portfolios come together only after reading occasional tips from pros. Such hodgepodges don’t work.
Beyond academic research, I’ve interviewed lots of investing experts over the years. Some of them, such as Bill Miller at Legg Mason, have been very informative and willing to help me translate their most successful techniques into methods appropriate for individual investors.
For The 3% Signal, I needed to strike out on my own. It brings together everything I’ve learned in two decades of researching and writing about stock market investing and distills it down to the best practice I’ve been able to devise. I’m proud of it, and believe it has the potential to upend the industry and finally free a legion of individual investors from the stress and indecision that accompany listening to forecasters, who as a group are proven to be wrong half the time. This is not a rhetorical statement. Several academic and industry studies have shown the average accuracy of professional forecasters to be at or a little below 50 pct — a coin toss.
To help me with the extensive data crunching necessary to prove that The 3% Signal beats the market and pros over time, I worked with an investor and programmer named Roger Crandell, whom I met when he subscribed to The Kelly Letter. We later became friends and he helped me with software and spreadsheets to verify my conclusions.
Your previous book, The Neatest Little Guide to Stock Market Investing has had an impressive run, selling more than 225,000 copies in its five editions. Tell us about your experience writing the book.
The book has grown with me. When I look back at how much it’s improved over time, I can see all the lessons I learned finding their way into the text. When I wrote the first edition, I relied almost entirely on the wisdom of more experienced investors because I didn’t have enough of my own wisdom yet to offer. What I was good at was gathering different viewpoints, seeing where they agreed and disagreed, and combining them into what I saw as the overall best approach by the best people on Wall Street.
Later, I found my own preferences within this overall best approach and realized that a more focused bit of advice was needed. The risk in distilling only mainstream industry viewpoints is that the resulting program will achieve only middling results, the fat part of the bell curve. As with almost every approach to investing, that one is doomed to lose to indexes. I decided that if I couldn’t offer a method with a reasonable chance of beating indexes, then I should just write another book recommending indexes. I didn’t want to do that, not in the way that it’s always done, which is to just advise buying and holding or dollar-cost averaging into the main market, so I kept looking for the little edges I could find.
I found them, too. One of them was a value averaging system that occupies a tiny corner of The Neatest Little Guide to Stock Market Investing, and it grew into The 3% Signal.
How did The Kelly Letter get started?
As a way to help readers run a real-time investing program with the advice they’d read in my books. At some point, theory needs to end and orders need to be placed. I used to send out tips to people on my free email list. A few readers asked if they could pay me for more in-depth articles. Then a few more asked the same thing. The first incarnation of my newsletter was a printed paper one sent from my office in Los Angeles. It was called The NeatSheet. When I moved to Japan, I needed to go all digital, and the name of the digital publication became The Kelly Letter. Like my stock book, it has grown over the years as I’ve become better. It’s very good now, based entirely on the signal system explained in my new book.
How was your system that’s presented in The 3% Signal created?
Through a lot of trial and error. The initial thought experiment that kicked off the desire to research it further was related to dollar-cost averaging, or DCA. It’s the sending of a constant amount of money to an investment on a regular schedule, such as every paycheck or once a month. DCA is popular because it’s easy, and it automatically buys more shares of an investment when the price is lower and fewer shares when it’s higher. If you send $100 per month, for example, you’ll buy 20 shares when the price is $5 but 5 shares when the price is $20, automatically. This lowers the average price you pay for an investment to less than its average market price during a time period.
The question that arose when looking at DCA was this: Wouldn’t it work better to send more money when the price is lower and less money when the price is higher? More questions followed. Wouldn’t it be better to send no money if the price is too high? Wouldn’t it be best to actually sell some of the investment if the price goes too high? The obvious answer to these questions was yes. From there, I set off to find ways to determine whether a price was high or low, how to figure the order adjustment based on that, and other details that became 3Sig.
How successful has the technique been?
Very. 3Sig beats buying and holding most indexes, beats all indexes in a program in which the investor adds more money over time (which is what the vast majority of individual investors does, in retirement accounts, etc.), and because most pros lose to indexes it runs circles around just about every famous talking head in the investing media. I’m not kidding. The household names of Wall Street can’t keep up with 3Sig, and therefore try to pretend it doesn’t exist.
It’s basically unbeatable by non-chance-based investing approaches, by which I mean systems that rely on methodical management rather than “gut instinct” and other casino approaches that hope for dashes of luck. Most newsletters are of the latter variety, trumpeting their successes and ignoring their mistakes, and a waste of time. Their editors are not engaged in a practice that is reliable and repeatable. They guess at which stocks will win and which will lose, and they’re right about half the time. This is not enough to trump the market, so they lose.
Among reliable approaches that are measurable because they can be applied in retrospect to past data, and are simple enough for ordinary people to manage, 3Sig is the champion. One aspect of it that I like is that it’s easy to understand why it wins. It uses a small-company index for the growth part of its portfolio. Small companies have beaten large companies over time and have been the best growth segment of the market. The 3Sig formula adds extra performance on top of whatever index it’s using for growth. Therefore, if 3Sig is adding performance on top of the market’s best growth segment, it will naturally beat the entire market. Since pros lose to the market, it will beat them, too. In short, it beats everything and everybody!
In Chapter 7 of the book, I show how three investors earning the same amount of money and investing the same percentage of their salary in the same set of 401(k) choices fared over the 12.5-year time frame from the end of 2000 to the middle of 2013. It included two bull and bear markets, so was a perfect period to use as a backdrop. One of the investors (Garrett) followed media tips from coin-tossing pundits, another (Selma) ran DCA in industry-leading funds, and the third (Mark) ran 3Sig.
It wasn’t even close. Garrett the pundit follower was a goner from the get-go, as is anybody who follows media tips. The relentlessly dollar-cost averaging Selma did well by choosing superb funds and sticking with her plan through all but the worst of the 2008 crash. Mark following 3Sig was not able to fund all of his plan’s buy signals through the 2008 crash, but still crushed his rivals. Look at their ending balances at the conclusion of the 12.5-year time frame:
Here’s a chart showing the path of their balances along the way:
Most people running 3Sig will experience a similar margin of victory over competing methods — while paying no attention to the frenzy of Wall Street.
What has subscriber response been to The 3% Signal?
Subscribers love it. Whatever initial hesitation they felt when I said I was going to manage two of the letter’s tiers entirely by the 3Sig formula and use the formula to guide decisions in the third tier, was dispelled after they saw the formula successfully navigate several quarters of roller coaster headlines. It’s amazing to watch, actually, bordering on uncanny. Last year, it sold ahead of the crash into October, then bought near the bottom ahead of the fourth-quarter recovery. It did so without engaging in any forecasting.
It doesn’t always get the moves precisely right, but its way of buying low and selling high compounds over time in little bursts of outperformance that add up. It’s most appreciated by people who’ve tried using intuition, both their own and that of the experts, to pick stocks and then get the timing right for when to buy and sell them. This method is extremely hard on people, because they get it wrong half the time, yet it remains the method that Wall Street continues pushing because it racks up the most trading commissions and sells the most research and advice.
The stock market is a life wrecker for more people than is commonly acknowledged. Some of those who’ve made their way to 3Sig look upon the method like a newfound religion. I get this. When a person is in pain, they love what soothes the pain. 3Sig soothes stock market pain and heals portfolios.
This is why subscribers have come to love it, and why I believe new readers are going to love it, too.
What are some of the biggest mistakes that people commonly make when investing?
The number one mistake is assuming that their investing ideas count for anything. I hate to break it to people, but we all suffer from the 50 percent mistake rate. You think you know where interest rates are heading? You don’t. You think you know what the price of oil will be in six months? You don’t. You think you know which industry is going to post the highest growth this year? You don’t.
I’m not picking on any one person, because nobody knows these answers, but I need to be unequivocal on this point: You’ve been told that you need to be smarter than other investors to get ahead, but you can’t be smarter because everybody is equally clueless. Accept this and start investing in a way that doesn’t involve guessing the future. There’s a lot of wisdom to be gained from this acceptance and the change in behavior that naturally follows, both of the investing variety and the regular life variety. Humility is a virtue when it comes to facing the future.
Another biggie is not understanding that capital allocation matters. You can get it right five times in a row, but if you blow it in a big enough way on the sixth time, you’ll wipe out all the progress you made. Guess what? Most people make it to that sixth time — repeatedly. 3Sig stops the cycle. It protects people from their own worst instincts. It’s foolproof. It will never chase a harebrained idea, never bet the farm, never miss the bulk of a move, and never puke at the bottom of a bear market. You know what it will do? Nudge performance above the market’s through a series of quarterly actions based on prices alone.
Ideas and gut feelings? Spare yourself. In the financial markets, numbers and the easy math that tells you what to do with them are all that matter. Leave the guesswork to the pros and their 50 percent mistake rates.
What is the one thing you wish everyone knew about stock market investing?
That last thing I just mentioned, that numbers are everything. It doesn’t matter what you or I or the voice-of-the-moment on CNBC thinks will happen next. It matters only that the price of your small-company stock index fund finished the quarter with more than 3 percent growth and should be sold, or less than 3 percent growth and should be bought. That’s the whole story behind how to win at this game. Everything else is just distraction.
What other projects are you currently working on?
I’m focused on spreading the word about 3Sig. I feel that it really is the market’s best practice, the stock market solved, if you will, and that I don’t have much more to say on the subject. I’m still trying different permutations on the 3Sig plan, but nothing has yet turned out to be better than the base case. I doubt anything will.
Beyond 3Sig, I find myself at a crossroads. I’m considering what to write next and I have a feeling I’ll be heading in a new direction. With investing safely on autopilot, thanks to 3Sig, there’s a whole world to explore!
Huge fan of the book and strategy. My questions is around the funds not invested in the ETF. Would you ever take those funds and place them either in a ‘short’ or inverse equity ETF in the same market, or hedge in another clever way against the asset you’re using.
My thinking is that when it comes time to rebalance, you would be able to capitalise even further on the volatility. If the asset decreases in value then the short asset should be worth more, so you would benefit when you sold the short etf to buy the ‘long’ asset at a discount. Same goes for vice versa.
Just a thought at this stage, but i’m keen to hear your thoughts on this.
Thank you, Matt!
I haven’t tested this, but can tell from the spirit of the idea that it would take a clever bit of market timing for the short fund to work in favor — and the whole reason we need this strategy is that nobody is good at market timing. They’re good at calling dumb luck skill now and then, but not at reliable timing.
Because the market rises most of the time, the short fund would significantly crimp performance by adding a drag on the overall return. Already, using cash for the safe portion of the plan creates too much drag, hence the preference of using a bond fund for dividend income and some price appreciation, but even allocating a portion of the portfolio to a bond fund causes the plan to lose to a 100% allocation to small-cap stocks in some time periods. Stepping back not to the drag of cash but to the higher drag of a short fund would only compound this problem.
So, skip the short fund idea and go with a medium-term bond fund or a total market bond fund.
Thanks for researching, writing, and publishing 3% signal.
What % of total liquid net worth you recommend people manage using 3% signal strategy?
Your recommendation for a 70 year old retired couple?
You’re most welcome, Ishwar, and thank you for the more detailed email you sent separately. It’s a pleasure having you as a reader.
The 3Sig plan is reliable enough for me to advocate putting all of one’s financial market portfolio into it. The plan comes with a schedule for adjusting into a safer posture for retirement, which you can see in “Adjusting Your Bond Balance as You Grow Older” on p. 152, and Table 33 on p. 153. If a 70-year-old couple is at “Retirement + 5″ in the table, then the schedule calls for a 40% target stock allocation, a 60% target bond allocation, and a rebalance when the bond allocation reaches 65%.
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