The Little Book That Still Beats the Market Ch. 4: Why It Works
阅读中文版The formula survives because it is painful to hold — professional career risk is what keeps the edge open.
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The Little Book That Still Beats the Market Ch. 4: Why It Works
"If the magic formula worked all the time, everyone would use it. If everyone used it, it would stop working. So the fact that it does not always work is precisely why it keeps working over the long run." — Joel Greenblatt
Investment Context
If the formula is this simple and this profitable, the obvious question is why everyone is not a billionaire. Greenblatt answers it in the book's most important chapter.
The formula works over ten-year horizons but frequently trails over one, two, even three years. Humans — professional managers above all — lack the tolerance to hold something that has lagged the market for three consecutive years.
The Wall Street Translation
Wall Street is judged quarterly. A mutual fund manager who trails the S&P 500 for two years straight faces redemptions and then dismissal. It is precisely because professionals cannot run this formula that the opportunity stays open to individuals.
1. The Pain of Lagging Is the Entry Fee
Buying formula stocks means buying companies the market currently dislikes. In the short run it may dislike them further and prices may fall.
Greenblatt's own backtest records that even across seventeen strongly outperforming years, the formula trailed in roughly one in five rolling twelve-month windows, including one stretch of three consecutive losing years.
2. Career Risk and the Individual's Advantage
This is a recurring insight across this library — Margin of Safety Chapter 5 makes the same argument: institutions bound by relative-return mandates are forced to sell at the worst possible moment. Individuals have no clients, no quarterly reports, and no risk of being fired, which hands them a structural advantage that almost all of them voluntarily surrender.
| Institutional manager | Individual | |
|---|---|---|
| Review cycle | Quarterly | None (self-set) |
| Consequence of 3 lagging years | Fired | None |
| Can tolerate deviating from the index | Barely | Entirely |
The right-hand column is your real edge, and the only way to exercise it is to do nothing.
3. The Ultimate Arbitrage
Value investing is fundamentally an arbitrage on human impatience. Because most investors demand immediate gratification, they dump good companies at unreasonable prices during temporary weakness — and the formula systematically takes the other side.
Actionable Trading Rules
- Commit to three to five years first: Do not begin unless you are psychologically and financially prepared to hold that long. If you plan to judge results after six months, failure is certain.
- Rebalance mechanically: Once a year, unemotionally, sell the portfolio, settle the taxes, and buy the new top 20 to 30. Do not let your opinion of any company interfere with the process.
- Reframe underperformance as cost: When the formula lags for a year or two, remember that the discomfort is the reason it keeps working. It is a fee, not a malfunction.
Relevance to a Retirement Portfolio
For retirees this chapter is worth more than the formula itself.
It explains why "hold low-cost index funds and leave them alone" — a strategy nearly everyone knows — still works: knowing the right answer and executing it through pain are entirely different things. If you discover you cannot sit through three lagging years, that is not a failure but valuable self-knowledge; it means your money belongs in the core index portfolio rather than in any active strategy.