There's some great investing advice out there -- and, of course, there's also pretty bad advice. In the latter category, you might have something like this: "It 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 started thinking about great advice that can be put into just four words. Let's see what we've got.
"Buy what you know"
This is probably the second most-famous four-word investing axiom. It comes from, or is at least most popularly attributed to, Peter Lynch's book, One Up on Wall Street. In a timeless article published several years ago, Jeff Fischer wrote at length about this phrase:
It 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, 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 become comfortable with the process, but it won't help you pick good stocks if you don't get into the valuation side of the equation.
Plenty of people bought Kodak (NYSE: EK) and Blockbuster (NYSE: BBI) a few years ago because they "knew" them, and those have been disasters. Plenty of people bought Starbucks because they knew it, and that's worked out great. 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 investing advice ever. As guidance, the phrase is unarguable -- 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 will sell at a higher price than what you've paid.
But the advice gives no guidance about what is "low" and what is "high." It can't be used without a whole lot of addendums. Buy stocks with low price-to-earning ratios, or at 52-week lows, or during bear markets; there are 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, might be never.
We can all tell plenty of stories about someone who sold a stock at a profit that seemed high but turned out to be several hundred or thousand percent below what the seller could have made by holding onto the stock. Tom Gardner frequently mentions Whole Foods and Daktronics when confessing his own bad calls. Not to pick on Tom -- his results speak for themselves -- but these were mistakes that came from 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 have little time to keep track of stocks, this really is the best investment advice around. It's not perfect -- after all, you might ask, "Which index fund?" And then you'd need to find one with certain characteristics:
- No load.
- Low annual cost.
- Low turnover.
- Broad index.
That means a fund such as Vanguard Total Stock Market Index (FUND: VTSMX), which might allow you to "buy what you know" because it holds a lot of what you know, including Bank of America (NYSE: BAC), Chevron (NYSE: CVX), and AT&T (NYSE: T), all of which are in the fund's top 25 holdings.
When cornered at cocktail parties for investment tips, that is the one piece of advice I part with. After all, barely 25% of mutual funds over time beat the relevant market index. I don't think that you can 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 have no load and be low cost, low turnover, and well diversified. It can, on rare occasions, be managed by someone or a team that has the ability to properly allocate capital and value businesses, thereby adding value beyond 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 several. 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.
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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. Starbucks and Whole Foods are Stock Advisor picks. Bank of America is an Income Investor pick. The Motley Fool has a disclosure policy.