Can an automatic do nothing approach to investing really work and help save individual investors from making common mistakes?

Joel Greenblatt is the founder of Magic Formula Investing and advises both individual clients and the Formula Investing Funds for Gotham Asset Management. Basically, clients who invest with him and Gotham, have two options. A set it and forget it managed option which is based entirely on the formula strategy of selecting stocks and when to trade them. The other option is for individual investors who gets to choose stocks from the same list as the managed option but they decide which ones to invest in and when.

 

A two year study was recently completed comparing individual investors to those of the managed funds.

A compilation of all individually self-managed accounts for the two year period showed a cumulative return of 59.4% after all expenses. Pretty good, right? Unfortunately, the S&P 500 during the same period was actually up 62.7%.

A compilation of all the “professionally managed” accounts earned 84.1% after all expenses over the same two years, beating the “self managed” by almost 25% (and the S&P by well over 20%).

So, what nuggets of inspiration and advise can we glean from this?  Consider the following points a starting point of what not to do.

1. Self-managed investors avoided buying many of the biggest winners.

Why? Mostly because many of the current “out of favor”, under-performing or trailing companies on the list end up, in the long run, being the biggest winners. A company that faces short term issues isn’t where most investors look for near term profits.

Is seems most people want to make money now. As a result, many of these out of favor companies are left off of self-managed investors lists.

2. Many self-managed investors changed their game plan after the strategy under-performed for a period of time.

Self-managed investors got discouraged after the magic formula strategy under-performed the market for a period of time and simply sold stocks without replacing them, held more cash, and/or stopped updating the strategy on a periodic basis.

3. Many self-managed investors changed their game plan after the market and their self-managed portfolio declined (regardless of whether the self-managed strategy was outperforming or under-performing a declining market).

Self-managed investors don’t like to lose money; even if “beating the market” means losing less than the market is. This is similar to #2 above. Most self managed investors pulled money out of stocks that were loosing money regardless of the fact that overall they were still beating the market.

Again, many out of favor stocks, end up coming back into favor and some even become the better performing stocks over time.

4. Many self-managed investors bought more AFTER good periods of performance.

By now you probably get the idea and see the pattern of the self-managed investor. Most investors sell right AFTER bad performance and buy right AFTER good performance.  Which is often counter to the very magic formula strategy they want to follow.

Now this is not a Fumbled Returns endorsement of any particular fund or stock or even method of investing. This is simply yet another example of some of the most common mistakes made by most average individual investors.

Mistakes that we all make. Even myself.

How many of us are impatient when it comes to money and investments? Do you have a buy it now and everybody loves a winner mentality, or do you have a longer term strategy of investing in good companies at bargain prices or waiting for that “got-to-have” item is actually on sale and at a bargain price.

In fact, I use the magic formula lists of stocks as part of my over all stock selecting strategy of creating my watch lists. The key word here is “part”. The other parts include momentum or hype stocks, stocks that sometimes never make the magic formula list. And, well, you guessed it. Sometime I do just as well, or worse, than the individual investors out there.

How about you?

What’s your money management and investment style?

And has is done better than the Automatic Do Nothing Approach?

Next up: Size Matters!