From Theory to Practice

Reading Joel Greenblatt's book is the easy part; actually executing the strategy requires a solid plan. Because the Magic Formula requires you to hold a basket of 20 to 30 stocks and rotate them annually, you need a systematic approach. If you jump in without a plan, you risk making emotional decisions or drowning in transaction fees.

Here is the exact step-by-step guide to building your Magic Formula portfolio from scratch.

Step 1: Prepare Your Capital and Broker

Before looking at any stocks, you need the right setup. Because you will be buying 20 to 30 different stocks and replacing them yearly, friction costs are your biggest enemy.

  • Capital: You need enough capital to justify the transaction costs. Generally, a minimum of $5,000 to $10,000 is recommended so that broker fees don't eat up your returns.
  • The Broker: Choose a broker with zero or extremely low commission fees (e.g., Interactive Brokers, Robinhood, or DEGIRO depending on your location).

Step 2: Generate the Stock List

Go to a Magic Formula screener. Not sure which one? See our comparison of the best free and paid Magic Formula screeners.

  • Enter your minimum market capitalisation (usually $50 million or $100 million).
  • Generate the top 30 to 50 stocks.
  • Crucial Rule: Exclude financial stocks (banks, insurance) and utility companies, as their financial structures distort the formula's metrics. Most dedicated screeners do this automatically.

Step 3: The Accumulation Phase (Pacing Yourself)

Greenblatt advises against investing all your money on day one. Instead, phase into the market to reduce timing risk.

  • Month 1: Buy the top 5 to 7 stocks on the list. Invest 20% to 25% of your total allocated capital.
  • Month 3: Run the screener again. Buy the top 5 to 7 new stocks that appear on the list.
  • Month 6 & 9: Repeat the process until your portfolio holds 20 to 30 stocks.

Step 4: The Holding Period (Do Absolutely Nothing)

This is the hardest step for active investors. Once you buy a stock, you must hold it for exactly one year.

  • Do not check the news about the company.
  • Do not panic if the stock drops 30% in a month.
  • Do not sell early if the stock doubles in a week.

Step 5: The Annual Rotation

Exactly one year after buying your first batch of stocks, it is time to rotate.

  1. Sell the stocks that have been in your portfolio for a full year.
  2. Run the screener again.
  3. Use the proceeds to buy the new top 5 to 7 stocks on the list.
  4. If a stock you already own is still on the new top 30 list, you can simply hold it for another year.

Conclusion

Building a Magic Formula portfolio is an exercise in extreme discipline. The actual work only takes a few hours a year. The rest of the time, your job is simply to let the math do its work and keep your emotions in check.

Wondering exactly how many stocks to include? We break down the math in our portfolio sizing guide. And don't forget the tax impact of annual rebalancing — our tax-smart investing guide shows you how to minimise the drag.