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The 4 Best Words of Investing Advice

There is some great investing advice out there, and, of course, some pretty bad advice. In the latter category, you might have something like this: "It just doesn't matter how high the price is -- buy all the Enron you can."

And while you can spend all day listing smart and useful investment advice, I got to thinking about great advice that is limited to four words.

Let's check the results.

"Buy what you know"
This is probably the second-most-famous four-word piece of investing advice. This advice comes from, or is at least most popularly attributed to, Peter Lynch's One Up on Wall Street. In a timeless article published several years ago, Jeff Fischer wrote at great length about this phrase:

[I]t is most often read to mean buy the brands that you know, buy the companies that make products that you like, and buy the company names that you always hear in daily life.

When large-cap stocks are soaring, this strategy, simple as it is, appears brilliant. "If I just buy Coca-Cola, General Electric, and Hershey, I could double my money every three years!" Of course, when large caps go into long periods of rest or retraction, the strategy requires patience and offers less than blistering returns, especially if you "bought what you knew" as it was hitting a seven-year peak.

"Buy what you know" is one-dimensional advice for three reasons. First, what you know may not be worth investing in. Second, the practice of buying what you know is rarely interpreted to mean buy the business model, the cash flow statement, and the balance sheet that you know backwards and forward. It too often is seen as "buy your favorite brand." Period. If you happen to know and love Kmart, but you didn't learn about its financials, you [were] in a sorry situation because you were an uninformed investor. Third, I've never heard the term "buy what you know" coupled with anything regarding valuation. It seems to be "buy what you know -- at any price."

Thank you, Jeff. "Buy what you know" may help new investors get comfortable with the process, but it simply won't help you pick particularly good stocks if you don't get into the valuation side of the equation. Plenty of people bought Ford (NYSE: F  ) and Krispy Kreme because they "knew them," and those have been disasters.

Alternatively, plenty bought Home Depot in the late '90s because they "knew it." However, because of the valuation back then, they haven't been well-rewarded, despite the growth of the company's business in the interim. Plenty of other people have recently bought Chipotle Mexican Grill because they knew it, and that's worked out very well -- so far.

Simply put, acting on "buy what you know" doesn't lead you down any path in particular.

"Buy low, sell high"
I'm pretty sure this is the most famous four-word piece of investing advice ever; as guidance, the phrase is unarguable -- and yet largely useless. By definition, if you succeed in buying low and selling high, you've made a profit. Any purchase is made with the expectation -- or at least hope -- that in absolute dollar terms, you're going to be selling at a higher price than what you've bought for.

But since the advice itself gives no guidance as to what is "low" and what is "high," it can't be used without a whole lot of addendums: Buy stocks with low P/Es, or at 52-week lows, or during bear markets, or any number of other interpretations of "buying low." Selling high might or might not be useful advice. After all, as Philip Fisher has famously written and as adopted by Warren Buffett, the best time to sell a stock, if it's properly researched, may be almost never.

We can all tell plenty of stories about someone selling a stock at a quick profit that seemed high but turned out to be several hundred or thousand percent below what they could have made by holding onto the stock. Tom Gardner frequently mentions Dell, Whole Foods, Sanderson Farms (Nasdaq: SAFM), and Websense (Nasdaq: WBSN) when confessing his own bad calls. Not to pick on Tom -- his results speak for themselves. But these were mistakes that came out of the "buy low, sell high" mold.

"Buy an index fund"
This is the most actionable, most mathematically supported, short-form investment advice ever. If you look up The Motley Fool in the encyclopedia -- or at least on Wikipedia -- you'll find that we are "famous for [our] view that, for the majority of people who have little time to keep track of stocks, the best investment strategy can be summed up in four words: 'Buy an index fund.'"

And that remains true. If you've got little time to keep track of stocks, this really is the best investment advice around. It's not perfect -- after all, you might be asking, "Which index fund?" And then you'd want to specify certain characteristics, such as:

  • No load
  • Low annual cost
  • Low turnover
  • Broad index

That means a fund like Vanguard 500 Index (FUND: VTSMX  ) , which coincidentally may hold a lot of what you know, including GE, Coca-Cola, and American Express (NYSE: AXP).

When cornered at cocktail parties for investment advice, this is the one piece I usually provide. After all, barely 25% of mutual funds over time beat the relevant market index. I don't think that you can really improve on this advice if you're stuck using four words or fewer.

But you can spend more than four words on investment advice, and as with the other four-word mantras above, if you do so, you usually get even better advice.

Like the classic index fund, a managed fund can be no-load, low-cost, low-turnover, and well-diversified. It can, on rare occasion, be managed by someone or some team that has the ability to properly allocate capital and value businesses and thereby add value over and above what the market average provides on its own. When you combine all of these factors, you get the potential to find a mutual fund that improves on the index fund and becomes something that will help you make money.

Such funds are out there. They take more than four words' worth of work to find, but Motley Fool Rule Your Retirement has uncovered a number of them. Along with a selection of exchange-traded funds that it recommends, as well as index funds beyond the S&P 500, our retirement newsletter focuses on inexpensive, diversified ways to save and invest for a healthy and happy retirement.

For much more on planning for retirement, including tools, investment recommendations, and a suite of discussion boards where you can ask questions to your heart's content, try Rule Your Retirement for the next 30 days, free of charge.

This article was originally published on Jan. 13, 2006. It has been updated.

Bill Barker owns shares of Home Depot, but no shares of any other company mentioned in this article. Home Depot, Dell, and Coca-Cola are Motley Fool Inside Value recommendations. Dell and Whole Foods are Stock Advisor picks. Chipotle is a Rule Breakers and Hidden Gems recommendation. The Motley Fool has a disclosure policy.


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