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The 4 Best Words of Investing Advice

There's some great investing advice out there -- and some pretty bad advice, too. If you've ever heard "It doesn't matter how high the price is -- buy all the Enron you can," that probably falls into the latter category.

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 IBM, General Electric (NYSE: GE  ) , and Hershey (NYSE: HSY  ) , 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 Boston Chicken and Krispy Kreme because they "knew them," and those stocks both proved disastrous. Plenty of people have bought automakers such as Ford because they knew it -- but that hasn't worked out for most shareholders. 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, yet it's 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, it will be sold at a higher price than it was purchased for. But since the advice itself gives no guidance about what is "low" or "high," it can't actually 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 it. Tom Gardner frequently mentions Dell (Nasdaq: DELL  ) , Whole Foods, Daktronics, and Sanderson Farms 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 is to 'Buy an index fund.'"

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, which coincidentally may allow you to "buy what you know" because it holds a lot of what you know, including Intel (Nasdaq: INTC  ) , Coca-Cola, Altria (NYSE: MO  ) , and Wachovia (NYSE: WB  ) , each of which is a top 30 holding. When cornered at cocktail parties for investment advice, this is the one piece I usually provide. After all, barely 25% of mutual funds beat the relevant market index over time. 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, doing so usually yields even better advice. Like the classic index fund, a managed fund can have no load, low costs, low turnover, and strong diversification. It can, on rare occasions, have managers capable of properly allocating capital and valuing businesses, thereby adding value beyond the overall increases of the market. When you combine all of these factors, you get a fund that improves on its index -- and helps 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 and 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 does not own shares in any of the companies mentioned in this article. Dell, Coca-Cola, and Intel are Motley Fool Inside Value recommendations. Whole Foods is a Stock Advisor pick; Dell is a former Stock Advisor pick. The Motley Fool has a disclosure policy.


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