However, the decree does include an exemption for firms whose guards work inside compounds used by foreign embassies and non-governmental organisations, even though Karzai's office said last week there would be no exceptions.
Karzai has repeatedly called for the banning of private security companies, saying they undermine government security forces.
The decision to disband the firms is linked to Karzai's ambitious plans to take over all security responsibility from foreign forces by 2014.
Waheed Omer, Karzai's spokesman, gave notice last week that the president intended to act over private security firms, calling it "a serious programme that the government of Afghanistan will execute".
"It's not about regulating the activities of private security companies, it's about their presence, it's about the way they function in Afghanistan ... all the problems they have created," Omer said.
Bryan Whitman, a Pentagon spokesman, said that while the United States shared Karzai's goal of eliminating private security firms and bringing them under the control of the central government, the four-month deadline was "very aggressive".
"With respect to a timeline of four months, obviously, that's a very aggressive timeline," Whitman said.
"We also recognise that Afghanistan still represents a daunting security challenge."
Private security companies in Afghanistan employ up to 40,000 people, including many Afghans, and are used to protect everything from convoys to military bases, embassies and non-governmental relief operations.
Al Jazeera's Hoda Abdel-Hamid, reporting from Kabul, said the conduct of private security personnel had in the past caused "a lot of uproar among the Afghan population".
"With respect to a timeline of four months, obviously, that's a very aggressive timeline"
"Their behaviour has always been questioned. Many of them were involved in accidents on highways where innocent Afghan civilians were killed," she said.
"[To ban those firms] is certainly a move that will be widely accepted by the Afghan people and it's certainly a move that comes at a very good time for the Afghan president.
"Parliamentary elections are expected to be held here next month and certainly this is a move that could could garner some support for the president."
Contractors in Afghanistan have been in the spotlight on several occasions.
In February, US senate investigators said the contractor formerly known as Blackwater hired violent drug users to help train the Afghan army and declared "sidearms for everyone'', even though employees were not authorised to carry weapons.
The allegations came as part of an investigation into the 2009 shooting deaths of two Afghan civilians by employees of the company, now known as Xe.