Investment Strategy Review
Invest Like Warren Buffett and the Gardner Brothers
A review of the market-beating strategies from Warren Buffett and The Motley Fool.
Warren Buffett, once the richest man in America, made his fortune with a simple investment strategy: Buy stock in good companies that sell a compelling product and are run by good people. This simple philosophy has allowed Buffett to beat the market year in and year out. David and Tom Gardner, creators of Fool.com and authors of The Motley Fool Investment Guide, have taken this strategy to heart and encourage others to do the same. Here is a brief review of what Warren Buffett and the Gardner brothers think about different investment strategies.
Mutual Funds
A mutual fund is a professionally-managed pool of investments that is diversified in stocks, bonds, and other securities. For the most part, mutual funds are the least volatile investments, which in turn decrease your risk, but also diminish your rewards. David and Tom Gardner argue that mutual funds are sub-optimal because they rarely beat the market and typically contain extra fees. Warren Buffett agrees saying “Wide diversification is only required when investors do not understand what they are doing.”
Index Funds
An index fund is essentially a mutual fund that tracks a specific index (i.e. the Dow Jones Industrial or the NASDAQ, etc.) These are typically more volatile than regular mutual funds, but have the upside of stronger growth over the long-run. The Gardner brothers recommend index funds for individuals who wish to invest, but only want to do the minimum amount of maintenance. Warren Buffett adds, “As far as you are concerned, the stock market does not exist. Ignore it.” Meaning, investing should not be about short-term gains but smart, long-term, investments which can be fulfilled by index funds.
Stocks
Purchasing stocks is the equivalent of purchasing small parts of a company. For this reason, and because of their high volatility, it is beneficial to know about the companies whose stocks you are purchasing. Many consider investing in stocks to be extremely risky and are content just to break even. However, The Gardner brothers believe, and Warren Buffett has shown, that all it takes to make money in the stock market is patience and good research. “You are neither right nor wrong because the crowd disagrees with you,” claims Buffett. “You are right because your data and reasoning are right.”
Margin Trading
When trading on margin you borrow funds from a creditor and pay interest on what you borrow. The benefit of margin trading is that if you invest wisely, your benefits will compound. However, there is also a risk of compounding your losses. This type of trading is not recommended by the Gardner brothers because the risk is not worth the reward. Additionally, Warren Buffett rarely, if ever, trades on margin.
Selling Short
Selling a stock short is effectively selling it at the current price, in the hopes that the price will decrease in the future, and then buying it back later. This is just as risky as margin trading because if the price goes up you lose the difference. The Gardner brothers have mixed feelings about this strategy because the risks typically outweigh the rewards, but there are also times when a good opportunity can be predicted.
Summary
“An investor needs to do very few things right as long as he or she avoids big mistakes,” advises Buffett. This mindset has made Warren Buffett the king of investing and it can work for anyone who puts in a little work and a lot of patience. Buffett urges investors to “never invest in a business you cannot understand.” Through this understanding, Buffett invests in companies that he knows will be good companies for years to come. If it works for him, it can work for you too.
Related Articles:
Resources:
The Motley Fool Investment Guide by David and Tom Gardner
Warren Buffett Quotes from About.com
