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The Rule of 20

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This is a good place to mention what is known as The Rule of 20. This is an equity market valuation method that refines the use of the PE as a guide to value in the overall market. The rule works on the premise that fair value in the equity markets exists when the aggregate of the market PE and the current rate of inflation is 20. If the sum comes to less than 20, the rule suggests the market will rise. Over 20, and the rule indicates the market will fall. The more extreme the figure, either on the low or high side, the more certain the indication. In essence, the rule is a simplified dynamic asset allocation technique.

It’s just a rule of thumb, but one which certainly passes my “3 Box Test” (referred to in the preface to this book). Over the years it has proved a very useful guideline that has helped me to decide whether to increase or decrease the current level of my equity investment.

Cotter On Investing

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