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Back in March, the new official Magic Formula Investing site was launched. In MagicDiligence's review of the changes, I mentioned that there was little doubt as to the motivation - to push Greenblatt's new Formula Trading venture to capitalize on the popularity of MFI. Formula Trading recently launched as an active service, so let's take a look at what it offers and what the terms are for interested investors. Is Formula Trading a good deal for current and future MFI investors?

There are two available plans at Formula Trading, labeled the Self-Managed and Professionally-Managed plans. The Self-Managed plan is pretty simple. It provides an MFI investor with essentially the same screening tool available at the official site, which the user can use to search for MFI stocks to fill his or her next purchase tranche. You run the screen, check off the stocks you want to buy, indicate how much money you want to invest, press a button, and you are done. The system also alerts you when the time approaches to sell a previous set of stocks.

The Professionally-Managed plan is a little more involved. Here, Formula Trading will manage your MFI account for you, automatically selecting stocks from the screen and selling previous purchases before or after their one year holding period, depending on gains/losses as explained here. It's a totally hands off proposition - put your money in and never think about it again, hopefully grabbing some of those eye popping returns reported in The Little Book that Beats the Market without lifting a finger.

Interestingly, both account types have the same minimums and expenses. The minimum account size is $25,000 dollars (additional accounts can be a minimum of $5,000). The annual expense ratio is 1% of assets, charged quarterly, with a minimum of $50 per quarter. If you do really well and get assets up over $1 million, Formula Trading cuts you a break and charges just 0.8% for assets over $1 million. Those are the only charges - there are no trading commissions, maintenance fees, or anything like that.

So is it a good deal? For the Self-Managed plan, it's hard to argue that it is. The cost would be a minimum of $250 a year for simply providing you a screen that's already freely available, and has also been duplicated (and, IMO, improved) by several other smart and technically savvy investors. The ability to click a few stocks and hit "go" is nice, as is the alert email, but these are hardly worth potentially thousands of dollars in charges a year. Sure, you save trading commissions, but the minimum assets is $25,000. With $25,000, you meet the minimum at Zecco to qualify for $0 trades, eliminating virtually any cost-effectiveness of the Self-Managed plan.

Trade stocks for free through Zecco.com, the Free Trading Community. www.zecco.com

The Professionally-Managed plan does provide some useful value. This plan effectively turns MFI into a personalized mutual fund, with that 1% charge similar to the expense ratio on a standard fund. In the managed fund world, 1% is not a particularly high ratio - the average is closer to 1.5%. However, Magic Formula Investing is designed to be a mechanical strategy. Formula Trading may manage your portfolio, but it's highly likely that a computer is making your stock picks for you. This is similar to many funds and ETFs designed to track market indexes. The catch here is that these kinds of funds and ETFs are designed to be low cost. The SPY ETF, tracking the S&P 500, has an almost 0% expense ratio! Even something like Vanguard's Total Stock Market Index (VTSMX), designed to track literally every stock in the entire market, charges just a 0.16% expense ratio and pays a dividend yield over 2%. That's less than 1/5th the cost Formula Trading is charging.

For those that like to pick their own MFI stocks based on a little due diligence, an $89 MagicDiligence Membership and a low cost broker is going to be much cheaper than Formula Trading. For those that prefer to have their MFI portfolio taken care of, Formula Trading is an interesting alternative, but the investor must ask if a few hours a year to manage his or her portfolio is worth possibly thousands in fees.

Steve owns no position in any stocks discussed in this article.

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Comments

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Posted by cookedc on 2009-07-04 18:40:09

Steve,

Glad to see your overview of Formula Investing. I too was sorry to see the fee structure of 1% per year. Let's say I'm working with a portfolio of $100,000 to $200,000; I'm willing to do some bookkeeping and stock trading on my own to save myself from paying one or two grand per year in fees. However, Greenblatt and his crew need to make some coin to keep the thing going and make it worth their while.

The problem of course to doing it yourself is, will you really have the discipline to stick with it and do all the trading at the specified times. I'm guessing that 98% of Magic Formula investors just won't stick with the rigorous process of rotating their portfolio of 20+ stocks on a regular once-a-year basis. It's human nature. Although I rely on MFI, I definitely fall into the 98% category.

Regards,
David

p.s. Keep up the good work at MagicDiligence.

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Posted by Steve on 2009-07-05 17:35:29

I should make it clear that I hope Greenblatt succeeds with Formula Trading (or Formula Investing, whatever it ends up). I think the MFI strategy is a great gift to individual investors and that he should profit from sharing his work. It makes good business sense to capitalize on what appeared to be a vacuum - automating the entire strategy. MagicDiligence was created to fill a void on what a lot of investors seemed to indicate with MFI - which stocks are really worth buying?

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