by Wayne A. Thorp
As this is my first installment of the Editors Outlook, I would like to take the opportunity to thank John Bajkowski for his many years as editor of Computerized Investing. He has been a mentor and an infallible resource to me over the almost nine years that I have been with AAII. I also want to thank him for the confidence he has shown in me with this opportunity. I will continue to rely on his wisdom and advice and, rest assured, you will still be treated to Johns insightful articles, such as the one in this issue.
Discount Broker Guide
Our annual comparison of on-line discount brokers lists 46 brokers this year. We appear to be entering a quiet period in the industry. After tremendous growth in the late 1990s, the industry started a period of consolidation that began in 2002. However, consolidation has slowed over the past few years and the number of brokers this year fell by only one. While the focus on consolidation may have shifted, specialization is still key to differentiating oneself from the herd.
The comparison covers a range of brokers. Factors such as investing style, typical holding period, and investment knowledge play important roles in determining which broker is right for you. If you are a frequent trader, then you will probably want to focus on deep discount brokers, who tend to offer the lowest commissions, or maybe even consider a broker that has a monthly fee, but a very low commission schedule.
There is more to the cost of trading than commissions. Quality of trade execution is just as important. This encompasses factors such as the price at which an order was filled, whether the broker was able to shop around for a price within the quoted bid/ask spread (known as price improvement), the speed at which the order was filled, and even the likelihood that an order will be filled when it is entered. All of these factors are related and involve some level of compromise. However, attempting order improvement may result in a slight delay of execution.
Placing a trading order is more science than art, but dont let that scare you. Intelligent use of limit orders or simply watching the intraday price movement of a stock can go a long way toward getting better fills. However, if you are planning on holding the stock for the long term, squeezing out that extra eighth of a point on the execution probably wont make much difference.
The comparison should offer a number of brokers that match your needs.
Magic Formula Investing
John Bajkowskis article discusses a magic formula to investing created by Joel Greenblatt, the founder and managing partner of Gotham Capital. Using middle-school math, Greenblatt outlines a simple approach to buying good companies at discount prices.
The formula itself isnt magic; it is based on principles that have been used to select stocks for decades—seeking out companies with a high return on invested capital that can be purchased at a low price that provides a high pretax earnings yield. The object is to create a portfolio of 20 to 30 of stocks that rank high on these factors. Since you are not performing individual company analysis, holding a significant number of stocks offers adequate diversification and allows the general principles of the approach to take hold. The article outlines the specific calculations used as well as the historical performance of the approach.