John Boone: ‘I tried using the Magic Formula investing method for 2006 and made a 25% return. I used the Magic Formula website to choose stocks. Recently, I Googled ‘Magic Formula Investing’ and found this website which claims that the Magic Formula website is not being maintained properly. Do you have an opinion on this?’

☞ My first-blush opinion is that if you made 25%, it couldn’t be that badly maintained.

MAGIC – AND TAXES

Prasanth: ‘I’ve been putting more and more money into a folio (I use FolioFN) of Magic Formula stocks since last June. (My return: 12.6%, which is ok – slightly less then the S&P500 including dividends. Would be 18+% if I had been putting the same amount into each stock purchase – again, been increasing my contributions.) However the one concern I have is taxes, because this in a nonretirement account and the magic formula is turning over a 100% each year. Yes, you are supposed to sell the losers less then one year after purchase and the winners a little after a one year to maximize tax losses vs. gains. But an average index fund has something less then 10% of turnover a year. Over the long term, couldn’t this significantly knock down the results from the Magic Formula even if does beat out the index in returns?’

☞ Yes and no. In the first place, the idea (though obviously not the guarantee) is to beat the index fund, over the long run, by a lot. But even leaving that aside, note two things.

First, while the index fund does a superb job of deferring your long-term tax liability – which is definitely an advantage, especially over long periods of time – taxes will have to be paid on those gains when you sell your index fund shares. Indeed, it’s possible that the tax rate might be higher then, although you will have had the use of ‘Uncle Sam’s’ share of your nest egg for all those years.

Second, there can be advantages to the tax control that do-it-yourself provides. This is especially true if you are at the point in your life where you are able and eager to make charitable contributions each year. Use the short-term losses to lower your ordinary income; some of the long-term gains to fund the charitable giving you would have done anyway. (Only, now do it through something like Fidelity’s Charitable Gift Fund.)

THE MAGIC OF CFLs

Tom Kabat: ‘It’s even better than you said. You said: ‘$32 a month savings for 40 years invested in a Roth IRA at 15% a year … works out to $728,953. Less the cost of replacing the bulbs every few years.’ But if I include an average 6%/year electric rate rise (like my utility has averaged for 20 years), the Roth IRA holding the savings grows to more than $1.18 million! Also you don’t need to subtract the cost of replacing the bulbs every few years since they will have saved more than their own cost in incandecsent bulbs. At any price less than $5/CFL the CFL costs less than the 10 $0.50 incandescents it replaces in its long life. I’m still giving away CFLs to charities, house warmings, stocking stuffers, tips, etc. just like I wrote to you in 2000. Instead of banning incandescents – my daughter still needs one in her SuzyHomeMaker Easybake Oven – maybe they just need a carbon tax of about $5 per bulb placed on them.’

MAGIC? YOU DECIDE

But how else can you walk on milky water?

 

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