Why Simple Is Not the Same as Easy

The Magic Formula is brilliant in its simplicity. All you have to do is print a list, buy 20 to 30 stocks, wait a year, and repeat. Yet the vast majority of investors who start with this strategy fail to execute it properly. How can a strategy that works so well in backtests go so wrong in practice? This is the hard reality.

Problem 1: Lack of Patience (The "Underperformance" Trap)

Joel Greenblatt himself admits it honestly: the Magic Formula doesn't work every year. There can be periods of 2, 3, or even 4 years in which the formula performs worse than the market average.

  • The mistake: Investors try it for a year, see the S&P 500 rising faster, conclude that the formula "no longer works," and stop.
  • The solution: Embrace the pain. Precisely because the strategy sometimes doesn't work for years, other investors abandon it. This is exactly what gives the strategy its edge over the long term.

Problem 2: Cherry-Picking

When you use the Magic Formula screener, the resulting list often contains unpopular companies. Perhaps a struggling retailer, a murky oil producer, or a company in the middle of a scandal.

  • The mistake: The investor thinks: "I'll buy stock A and B, but I'll skip C — I hate that company."
  • The solution: Follow the list blindly. Research shows that the ugliest companies on the list often generate the biggest returns. The moment you add human emotion, you break the formula's working mechanism.

This is a fundamental aspect of behavioural finance. Our article on the psychology behind the Magic Formula explains exactly which cognitive biases are at play — and why even intelligent investors fall into these traps.

Problem 3: Underestimating Transaction Costs

The Magic Formula requires you to sell your entire portfolio (or a large part of it) every year and buy new stocks.

  • The mistake: Investing through a broker with high transaction costs. If you pay high buying and selling fees annually for each of the 30 stocks, this eats into your returns.
  • The solution: Choose a reliable, low-cost broker. Also pay close attention to tax rules in your country regarding realised capital gains.

Conclusion: Discipline Is Your Only Edge

The secret of the Magic Formula is not in the mathematics — that's public information. The real secret is behaviour. Most people fail because they lack the discipline to maintain a contrarian, often uncomfortable course.

If you follow the mechanical rules and persist for at least 5 to 10 years, you belong to the rare group that reaps the rewards. The formula works. The question is whether you will let it.

Be sure to also understand the dark side of the Magic Formula — the drawdowns, value traps, and friction costs that can trip you up. And when you're ready to commit, our step-by-step portfolio guide will help you get started the right way.