A great book that lists long term returns of dozens of mechanical investing strategies is James O'Shaughnessy's
What Works on Wall Street.
Requires Minimal Time Investment.
Most of these strategies prescribe re-balancing the portfolio just a few times a year. In many cases, once a year suffices. Because of this infrequent buying and selling, and because stocks are selected directly from a screen, the time investment required is extremely low. No time is needed digging into SEC filings, listening to conference calls, glazing over balance sheets and cash flow statements, and so on. For that matter, no time requirement to learn how to do these things either! Beating the market while barely trying is a great argument for following a mechanical investing strategy.
Removes the Emotion from Investing.
This is the single greatest reason to follow a mechanical strategy. In the investing game, emotion is your worst enemy. It causes investors to buy when the market is high, and it causes them to sell when the market is low. Logically, this makes little sense, but fear and euphoria are powerful determinants of human behavior. Mechanical investing removes this from the equation. Cold, hard facts determine your investment choices. There is no risk of investing outside of your plan, hoping to catch lightening in a bottle, only to see your money disappear.
Mechanical investing has a lot of advantages. The two keys to being successful with it are to pick a good strategy and stick to it. With over 30% annual returns over a 17 year period, Joel Greenblatt's Magic Formula is clearly a great strategy. Sticking to it through thick and thin, though difficult, should provide followers with similarly excellent returns in the future.
Dis-advantages
In the previous article,
5 Advantages of Mechanical Investing, I laid out 5 main reasons that using a mechanical, or statistical, investing strategy like Joel Greenblatt's Magic Formula is an attractive investment plan. This article will present the flip side - 5 reasons why mechanical investing is not followed by many investors. So, with no further a-do:
- One-time Charges and/or Gains Can Skew Statistics.
One-time, or "special", charges and gains are a common fact of life in the investing world. For example, a company could sell a piece of real estate is not longer needs for a one-time gain, or take a one time charge for reducing the value of goodwill on the balance sheet. The problem with these is that they can greatly skew valuation statistics, adversely affecting a statistical screen. That one-time gain from a real estate sale can artificially inflate earnings, making the P/E ratio look much cheaper than it actually is based on on-going operations. Without taking the time to research the company's financial statements, this would go unnoticed by a mechanical investor. Good mechanical screens try to account for this, but it's not always possible for a computer algorithm to catch these discrepancies.
