I recently finished reading “The 3% Signal” by Jason Kelly. The book proposes a straightforward investment strategy designed to outperform traditional index fund investing. For someone like me who loves math-based approaches to investing and optimizing finances, this book was right up my alley. Think along the lines of experts like Michael Kitces or Wade Pfau—if you have solid data to back your strategy, I’ll listen.
Even though I believe in the power of index fund investing, I’ve always thought there must be more strategic ways to get ahead. Compounding returns, for example, is a simple math-based method to grow your money faster than you could by merely saving. Are there other similar strategies? It doesn’t hurt to dream.
By the time I finished “The 3% Signal,” I was almost ready to take the plunge. We recently sold our old house, leaving us with a decent amount of cash in savings, and I was eager to start investing it. But before diving into the 3% Signal strategy, I had to ask: Does it really work? I’ve read many books with grand claims of fantastic returns that fell apart under closer scrutiny. The 3% Signal deserves the same rigorous examination.
I downloaded the same data Jason Kelly used from Yahoo Finance and tried to replicate his results. This allowed me to back-test the plan for over 20 years. Using an extensive Excel spreadsheet, I factored in the small nuances of the plan, such as the “30 down stick around” rule and the 80/20 rebalance when bonds exceed 30%. Here’s how my results compared to Kelly’s:
While my results didn’t match Kelly’s perfectly, both showed the 3% Signal strategy generally coming out ahead. One notable difference appeared when adding cash every time the bond fund ran out of money. The results diverged significantly from Kelly’s findings. If anyone wants to examine my calculations, feel free to email me for a copy of my Excel document.
Kelly’s data only spans the last 12.5 years, which is too short a timeframe for me to trust completely. He used this period because it matched the availability of certain ETFs. To overcome this limitation, I used similar mutual funds extending back to 1994, which provided 21 years of data. Again, using Kelly’s rules, I found the 3% Signal strategy didn’t provide any marked advantage. In fact, adding extra cash resulted in lesser balances!
So, does the 3% Signal strategy have any merit? Yes, it offers stability. While it might not result in more money, it can reduce the volatility of your portfolio, which could be beneficial during retirement when capital preservation is crucial. If you’re accumulating wealth, the index approach might be better despite the occasional market bumps. But during retirement, the 3% Signal’s stability could be more valuable.
Kelly’s method of adding additional cash was also problematic. In Table 15 of his book, he assumes you invest all needed cash upfront, which is unrealistic. For Plan 3, he totals the additional cash added over the 3% Signal plan and divides it over 50 quarters—again, unrealistic for someone just starting.
I took a different approach in my analysis. Whenever additional cash was required for the 3% Signal plan in a specific quarter, I bought the same number of additional shares in the Index Only approach for that quarter, ensuring a fair comparison. This method likely contributed to the differences between my calculations and Kelly’s.
In summary: If you’re in the wealth accumulation phase, sticking with index funds might be more beneficial. However, if you’re in retirement, the 3% Signal’s stability could be advantageous.
