The 4% Rule:
The 4% Rule investment strategy was developed by Ned Davis of Ned Davis Research, and highlighted in Martin Zweig's investment classic, 'Winning on Wall Street.' The 4% Rule is a mathematical timing model that automatically gives 'Buy' and 'Sell' signals based on the weekly closing price of the major stock market indexes, ignoring the daily gyrations.
The 4% Rule has an exceptional record of outperformance over the long term, and can be used by the trader as a stand alone trading strategy; as a first step to highlight whether the trader should be buying, selling, or shorting stocks in the current environment; or as a way to manage longer term investments, such as mutual funds in a 401K.
If you had put $10,000 into the Value Line index - a widely used proxy for the overall stock market -your balance would have grown to $77,763 from 1966 to January, 2003 - a 5.7% annual return - if you had held the index throughout the 37 year period. If, instead, you had switched into a money market fund during those times when the 4% Rule was in 'Sell' mode and into the Value Line index when in 'Buy' mode then your $10,000 would be worth $1,651,390, over the same time period - a 14.8% annual return. That is 21 times the value of the buy-and-hold account! Even more amazing, that exceptional outperformance comes with less risk, since you are in cash equivalents almost half the time.
Most 401K investors will be unable to invest in the Value Line index, but there is a direct performance relation to Mid Cap funds, which are routinely offered in such retirement accounts. Choose a Mid Cap index fund as your Value Line conduit if at all possible, since the fees are substantially lower than for actively managed funds. If the Mid Cap option is unavailable to you, then choose a Small Cap fund. If Small Caps are unavailable, then choose a Growth fund. Be careful to check if any fees are charged for switching in and out of funds in your 401K, and that your company allows you to make changes at least 5 times per year - the average number of Buy and Sell signals the 4% Rule makes on average is 4.5 per year.
Using the 4% Rule over the past 4 decades would have allowed you to miss the bulk of the 1973/74 bear market, miss the 1987 crash entirely, and miss most of the recent bear market. More money with less risk, and in cash during bear markets and crashes: what a deal!
Results are tabulated using the opening price the day following a new trading signal, and exclude commissions, dividends, or interest paid on cash balances during sell periods. Stock prices highlighted in blue are temporary - using the end of day quote the day a new buy or sell signal is generated - with the final price adjusted the following trading day when the opening price is available. Past performance is no guarantee of future success
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