Joel Greenblatt, the American Hedge Fund Manager and investor wrote “The Little Book that Beats the Market” in 2005 describing a 2-factor investing strategy.
The strategy was based on “Earnings Yield” and “Return on Invested Capital”.
The strategy was based on selecting the Top 30 stocks by ranking on these 2 criteria.
Investors who use the strategy sell the losing stocks before they have held them for one year to take advantage of the income tax provision that allows investors to use losses to offset their gains. They sell the winning stocks after the one-year mark, in order to take advantage of reduced income tax rates on long-term capital gains. Then they start the process all over again.
Greenblatt claimed a 30% outperformance through this strategy in his book.
The strategy looked great academically, however executing the strategy year-on year basis provided difficult when Greenblatt tried executing it.
Greenblatt’s book became a best seller; however, a lot of readers wrote back to him for help executing the strategy.
Subsequently in 2009, Greenblatt launched “Formula Investing” to help investors execute the strategy.
Investors had 2 options-DIY or ask the firm to execute.
How Did it Fare?
Formula Investing allowed money to be managed in a disciplined manner that removes factors, like excess emotion and future projections, that often lead to bad investment results.
Over the next couple of years, Greenblatt realized, how the DIY investors did badly compared to those being helped by the firm.
The reason was simple, the DIY investor applied their instincts to using the strategy which meant piling on the strategy when strategy was doing well and exiting when markets were falling.
These were exactly the traps that the strategy was seeking to avoid.
There are no “rights” or “wrongs” in investing like a lot of other aspects in Life.
You do what is right for you and you don’t do what you feel is not “right”.
The key is can you follow this approach consistently and with discipline without mixing emotions and judgement calls.
There is always something to be worried about in the markets.
Can the “noise” be filtered to stick to your “discipline”.
If the answer is yes, you will realize that you do not need any “magic formula”.
You will get the outcome that your risk-profile determines without falling prey to day-to-day worries of the world.
Difficult, not “Impossible”
As we have realized, however, this is the most difficult part of investing.
It is not about right stock, right time, right platform.
It is about “Discipline”.
That’s what “Even the SMARTEST” need as a strategy.
Happy Investing and “Stay the Course”