Category Archives: Investing

Magic Formula

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“Believe it can be done. When you believe something can be done, really believe, your mind will find the ways to do it. Believing a solution paves the way to solution.” – David J. Schwartz

In “The Little Book That Beats the Market”, Joel Greenblatt, Founder and Managing Partner at Gotham Capital (average annualized returns of 40% for over 20 years), sets out the basic principles for successful stock market investing.

In his book, Greenblatt provides a “magic formula” that makes buying good companies at bargain prices process driven. It takes a bunch of stocks (Russell 3000) and ranks them on quality; takes the same bunch and ranks them on value. Add the two ranks and buy the stocks with the highest summed ranks. Hold them for a year or preferably longer.

The formula is based on two very solid pillars of value investing: Invest in companies with high returns, and make sure they’re selling at a large discount (margin of safety).

For his quality factor, Greenblatt chose return on capital, defined as EBIT (earnings before interest and taxes) divided by the sum of working capital and fixed assets. For his value factor, Greenblatt chose EBIT divided by enterprise value.

“If you just stick to buying good companies (ones that have a high return on capital) and to buying those companies only at bargain prices (at prices that give you a high earnings yield), you can end up systematically buying many of the good companies that crazy Mr. Market has decided to literally give away.”

“Choosing individual stocks without any idea of what you’re looking for is like running through a dynamite factory with a burning match. You may live, but you’re still an idiot.”

“In short, companies that achieve a high return on capital are likely to have a special advantage of some kind. That special advantage keeps competitors from destroying the ability to earn above-average profits.”

“Stock prices move around wildly over very short periods of time. This does not mean that the values of the underlying companies have changed very much during that same period. In effect, the stock market acts very much like a crazy guy named Mr. Market.”

“Although over the short term, Mr. Market may set stock prices based on emotion, over the long term, it is the value of the company that becomes most important to Mr. Market.”

“After more than 25 years of investing professionally and after 9 years of teaching at an Ivy League business school, I am convinced of at least two things: 1. If you really want to “beat the market,” most professionals and academics can’t help you, and 2. That leaves only one real alternative: You must do it yourself.”
― Joel Greenblatt, The Little Book That Beats the Market

“Over the short term, Mr. Market acts like a wildly emotional guy who can buy or sell stocks at depressed or inflated prices. Over the long run, it’s a completely different story: Mr. Market gets it right.”

“Although over the short term Mr. Market may price stocks based on emotion, over the long term Mr. Market prices stocks based on their value.”

Greenblatt’s three basic principles:

  1. Buy good companies;
  2. Buy them at bargain prices;
  3. Use ranking to pick stocks.

Financial commentator Gary Shilling likes to say, “The stock market can remain irrational a lot longer than you can remain solvent.”

T,hus, when looking for bargain prices, you need to look at a lot more things than earnings yield, and when looking for good businesses, you need to look at a lot more things than high return on capital.

You can’t judge a business as good or bad without looking at its stability, its growth prospects, and the quality of its earnings; and you can’t judge a business as a bargain without looking at a variety of valuation metrics.

References:

  1. https://www.goodreads.com/work/quotes/73414-the-little-book-that-beats-the-market
  2. https://www.fool.com/investing/general/2007/03/23/foolish-book-review-the-little-book-that-beats-the.aspx
  3. https://seekingalpha.com/article/4374333-how-market-beat-little-book-beats-market-stock-pickers-guide-to-joel-greenblatts-magic

Differences Between Price and Value

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“Price is what you pay; value is what you get.” Warren Buffett

“Don’t judge a company’s stock by its share price.” Many people incorrectly assume that a stock with a low dollar price is cheap, while another one with a four-digit dollar price is expensive. In fact, a stock’s price says little about that stock’s value. Moreover, it says nothing at all about whether that the market price of a company is headed higher or lower.

The most important distinction between the ‘market price you pay’ and the ‘intrinsic value you get’ is the fact that price is arbitrary and value is fundamental.

  • Price is the amount paid for the product or service.
  • Cost is the aggregate monetary value of the inputs used in the production of the goods or services.
  • Value of a product or service is the utility or worth of the product or service for an individual.

To effectively deploy this strategy, it’s essential to find a company that you understand, that has solid fundamentals — then be patient and wait until the company’s stock price falls below its intrinsic value before you purchase the company.

Regarding ‘understanding’ a company, it’s important for investors to know how a company makes its money–revenue, profits and free cash flow.

At some point, a stock’s market price over the long term adjusts to its intrinsic value. This fact is how successful investors such as Warren Buffet have used to make billions over the long term.

“Finding differences between price and value is by far the most effective investment strategy”, writes Phil Townes, founder of Rule One Investing . “Not recognizing differences between price and value is also what causes many investors to lose their shirts, as companies are just as often overpriced as they are underpriced.”

How do you find companies that are on sale for less than their true value is to evaluate companies using a set of standards that look beyond the company’s current price tag. Phil Town call these standards the four Ms:

  • Meaning,
  • Moat,
  • Management and
  • Margin of Safety

The first step is to make sure you understand the company and the company you invest in has meaning to you as an investor. If it does, you’ll understand it better, be more likely to research it and be more passionate about investing in it.

The second step is to choose a company that has a moat. This means that there is something inherent about the company that makes it difficult for competitors to step in and carve away part of their market share.

The third step is to look at the company’s management. Companies live and die by the people managing them, and if you are going to invest in a company, you need to make sure their management is talented and trustworthy.

Finally, calculate the company’s intrinsic value and determine a margin of safety. Margin of safety is the price at which you can buy shares of a company, being more likely that you won’t lose money and have increased confident that you will make a good return on your invested capital.

When the market price of a company is lower than the company’s intrinsic value number, the company is deemed underpriced and represents a great investment opportunity.

“Leveraging differences between price and value is as simple as that”, said Town. “Find a company that you believe in, that has solid fundamentals — then wait until their price falls below their value. If you do this, you can buy companies on sale, sell them for their true value and make a lot of money in the process.”

The goal is to identify stocks that are undervalued—that is, their market prices do not reflect their true intrinsic value.

References:

  1. https://www.forbes.com/sites/forbesfinancecouncil/2018/01/04/the-important-differences-between-price-and-value/
  2. https://keydifferences.com/difference-between-price-cost-and-value.html
  3. https://www.investopedia.com/articles/stocks/08/stock-prices-fool.asp

The overriding goal is to help individuals learn how to successfully invest in assets, to build long term wealth and achieve lifetime financial freedom. 

Inflation Will Persist

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“Inflation is like chewing gum. It’s sticky and flexible, and you definitely don’t want to step in it.” Capital Group

For the past 30 years, investors haven’t had to worry much about dealing with inflation, says Capital Group fixed income portfolio manager Ritchie Tuazon. That changed last summer when COVID-related distortions and excessive government stimulus caused prices for energy and most consumer goods to skyrocket.

Today, the biggest questions for long term investors are how high will inflation go and how long will it last?

Adding to the uncertainty is that there are two types of inflation, according to Tuazon:

  • Sticky inflation tends to have longer staying power. Sticky categories include rent, insurance and medical expenses.
  • Flexible inflation — affecting items such as food, energy and cars — has risen much faster in recent months but many believe it won’t last.

From Capital Group’s perspective, they expect high inflation might persist longer than expected and should move closer to its 2% historic goal by sometime in 2023.

Higher inflation levels should remain elevated through late 2022, fueled by labor shortages and broken supply chains. “Consumer prices will eventually return to normal, but that process may take longer than Fed officials are expecting,” says Tuazon.

The Fed is left to react to inflation, but not overreact. Start, but not go too fast. Tighten, but not in the “wrong” ways.

Regarding inflation impact, “the first question is whether inflation will cool off enough on its own to not threaten corporate earnings growth or hurt consumer spending”, states Liz Young, Head of SoFi Investment Strategy. “The second question is less about whether the Fed can control inflation expectations with policy moves and more about whether the market is going to think they’re making a mistake and create a self-fulfilling prophecy.”

References:

  1. https://www.capitalgroup.com/advisor/pdf/shareholder/MFCPBR-086-652781.pdf

Don’t Fight the Fed

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“We continue to believe that the S&P will see a correction of at least 20% over the next one to two years as the Fed is more aggressive than expected to deal with inflation running higher than expected and easy money begins to decrease.” Dan Niles

“The markets are in a volatile and dangerous place as of now,” writes Dan Niles, founder and portfolio manager for the Satori Fund.

In his article entitled “Market Thoughts Following Q1”, Niles contends that investors heed the warning: “Don’t Fight the Fed”.

He states that “Investors are forgetting that it [Don’t Fight the Fed] works on the way down as well as the way up. The Federal Reserve (The Fed) expanded their balance sheet by $4.8 trillion since the start of the pandemic while the US government added ~$5.5 trillion in stimulus. Combined stimulus of roughly half of US GDP of $20.5 trillion is the major driver of why the prices of stocks (along with homes, cars, boats, crypto, art, NFTs, etc) all went up over the past two years during a global pandemic. Now, the Fed dot plot shows 10 rate hikes in less than two years and they will be cutting trillions off the balance sheet probably starting on May 4th along with a 50 bps rate hike.”

“The #1 concern for investors in 2022 should continue to be that the Fed is so far behind the curve on dealing with inflation that they will have to be much more aggressive than in prior tightening cycles despite high inflation & geopolitical risk.” Dan Niles

“We [Satori Fund] continue to believe that the S&P will see a correction of at least 20% over the next one to two years as the Fed is more aggressive than expected to deal with inflation running higher than expected and easy money begins to decrease. Since World War II,

  1. Every time Inflation (CPI) is over 5% a recession has occurred
  2. Every time oil prices have doubled relative to the prior 2-year average ($54 in this case) a recession has occurred
  3. 10 of the 13 prior recessions have been preceded by a tightening cycle by the Fed
  4. 10 of the last 13 recessions have been preceded by the 10-year yield going below the 2-year yield”

For retail investors, Niles recommends “cash until inflation, Fed tightening and economic slowing run their course over the next one to two years. He writes that “most of the time, cash is a terrible investment especially in a high inflationary environment, but it is better to lose 6-7% to inflation this year than 20%+ in a stock market drop. With the Fed being this far behind the curve on inflation, we will find out how much froth is in valuations as the Fed starts tightening as growth continues to slow.”

Satori Fund likes companies that

  1. Benefit from economic reopening (not pandemic beneficiaries);
  2. Are profitable with good cash flow;
  3. Have growth but at a reasonable price;
  4. Benefit from higher-than-average inflation;
  5. Benefit from multi-year secular tailwinds. 

They foresee investing tailwinds in:

  • Datacenter, office enterprise, and 5G infrastructure.
  • Reopening plays such as airlines, cruise lines, travel, rideshare, and dating services as people adjust to covid becoming endemic.
  • Banks which should benefit from higher interest rates.
  • Alternative energy as geopolitics and fallout from the Russia-Ukraine War drives investment in the space.

References:

  1. https://www.danniles.com/articles

Wall Street Driving Up Rents and Housing Prices

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The government has estimated that the nation is short about 4 million homes, and that number is likely growing.

A good examples of just how wild the housing market has become in Florida, look no further than the city of St. Augustine. A property has been on the market for thirty days with a disgustingly steep price considering the home’s exceptionally run-down (think ugly shabby) condition.

Asking price $349K on Zillow

This house is listed as a “Major fixer upper!!! Property to be sold AS-IS” on Zillow. It’s a 448-square-foot, one-bedroom, one-bath home that has definitely seen better days. The asking price is a whopping $349,000.

With housing in such short supply, Wall Street saw an opportunity, and began buying modest, single-family houses. Once bought, they rent them out. In places like Jacksonville, Atlanta, Charlotte, investors are buying almost 30% of the homes that are available for regular home buyers.

These Wall Street companies come in and buy a home, paying at or above market price for the home. And then, they set a market rent, charging 30%-40% higher rent than the previous owner asked.

References:

  1. https://www.news4jax.com/news/local/2022/03/24/want-to-buy-a-fixer-upper-in-st-augustine-this-1-bedroom-house-is-for-sale-for-349000/
  2. https://www.zillow.com/homedetails/112-Moore-St-Saint-Augustine-FL-32084/47777206_zpid/

Investing Involves Decision Making

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Investing involves decision-making. But not making those investing decisions can be a more costly move in itself.

Choosing to invest your money in the stock market is like picking your first tattoo. The stakes are high and all the available options can seem overwhelming to your senses. Thankfully, there is an an abundant amount of good financial services, resources and advice available to help you avoid making a mistake mistake and to get you started.

There is truly no time like the present to start investing. Because the sooner you start, the more time your money has to grow and the more potential you have to earn, because of the power of compound interest. This is when your money earns money on itself and grows exponentially.

But, growth isn’t always guaranteed. Investing means taking in a certain amount of risk since the market moves in cycles. Although investing comes with some risk, it doesn’t have to feel like a high-stakes gamble.

Rest assured, historically, stocks have bounced back from every downturn in history. And, then continued to climb. Investing consistently overtime can make it easier to ride out the market volatility, the ups and downs.

The first step is determining what you want your future to look like financially in retirement. Retirement is probably your most important and expensive goal, and a good place to start.

It’s important to build a portfolio based on your time horizon, how you want to invest, how comfortable you’re with risk and what you plan to use your investment earnings are for. But, you must get started.

Ready, set, go(als).

Investing could help you owe the IRS less during tax time. For example, you have until the tax filing deadline each year to open and fund an IRA, which could help you claim an extra deduction.

Harvesting losses in your brokerage account could help you reduce your capital gains taxes for the year.

If you want more control over your investment portfolio, self-directed investing is the way to go. Self-directed investing is for people at all experience levels.

However, if you prefer a hands-off approach, financial advisors or automated robo-advisors can help you capture your financial goals and tailor an investment portfolio to achieve your financial goals, complete with regular rebalancing.

But, before you jump headfirst into investing your money, it’s wise to assess your present financial status first (your cash flow and net worth) and make sure you’ve got a solid savings foundation to build on.

Finding a balance between saving your money and building wealth through investing for your future is not rocket science. It is simple to build savings and help take the fear and uncertainty out of investing.

References:

  1. https://taskandpurpose.com/from-our-partners/set-your-future-up-for-success-save-and-invest/
  2. https://www.brighthousefinancial.com/education/retirement-planning/covering-everyday-expenses-in-retirement/

Staying Invested Matters

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Investors are more likely to reach their long-term goals if they remain invested and avoid short-term decisions that may take them off course.

Staying the course during market volatility is often difficult for many investors. Some choose to move to cash investments, while others try to time the market. Regrettably, these investors are often buying high and selling low—and miss the rallies that follow the challenging periods.

Yet, staying invested through market ups and downs can help you stay on track to reach your investment goals.

Once you’ve determined how much you want to invest, setting up automatic transfers to your investment account or periodic investments can help you stay on track.

For example, investors often make suboptimal investing decisions when emotions take over, tending to buy out of excitement when the market is going up and sell out of fear when the market is falling. Markets do ultimately normalize, and when they do, those who stay invested may benefit more than those who don’t.  Consider this:

  • By missing some of the market’s best days, investors can lose out on critical opportunities to grow their portfolio. Market timing can have devastating results.
  • Seven of the best 10 days occurred within two weeks of the 10 worst days.
  • The second worst day for the markets during the early days of the COVID-19 pandemic, March 12, 2020, was immediately followed by the second best day of the year.

Trying to time the bottom is never considered a sound strategy for long-term investing.

Staying invested during periods of heighten market volatility is an important strategy as, historically, six of the ten best days in the market occur within two weeks of the ten worst days; those who miss the best days miss out on performance.

Thus, the decision to stay invested during market turmoil is often better than timing
when to sell and buy.

References:

  1. https://am.jpmorgan.com/us/en/asset-management/adv/insights/market-insights/principles-for-investing/
  2. https://www.pimco.com/en-us/resources/education/the-benefits-of-staying-invested/

Benjamin Graham

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Every investment is the present value of all future cash flow.

Benjamin Graham, colleague and mentor to billionaire investor Warren Buffett,  is widely acknowledged as the father of value investing. His timeless book, The Intelligent Investor, is considered the value investor’s bible for both individual investors and Wall Street professionals.

Many of Benjamin Graham’s concepts are deemed fundamental for value investors, and his concepts should be studied and followed for anyone who plans to invest long term in the stock market.

For example, “Margin of Safety” is the famous term coined by Ben Graham. In simple terms, an asset worth $100 and bought at $80 has a better Margin of Safety than the same asset purchased at $95. In other words, “A great company is not a great investment if you pay too much for the stock”,  according to Benjamin Graham.

The 10 Benjamin Graham quotes, all of which are valuable in today’s market, tell us that::

  1. “A stock is not just a ticker symbol or an electronic blip; it is an ownership interest in an actual business, with an underlying value that does not depend on its share price.”
  2. “People who invest make money for themselves; people who speculate make money for their brokers.”
  3. “While enthusiasm may be necessary for great accomplishments elsewhere, on Wall Street, it almost invariably leads to disaster.”
  4. “Basically, price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal.”
  5. “Obvious prospects for physical growth in a business do not translate into obvious profits for investors.”
  6. “An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.”
  7. “To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks.”
  8. “The intelligent investor is a realist who sells to optimists and buys from pessimists.”
  9. “The investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage. That man would be better off if his stocks had no market quotation at all, for he would then be spared the mental anguish caused him by other persons’ mistakes of judgment.”
  10. “Weighing the evidence objectively, the intelligent investor should conclude that IPO does not stand only for ‘initial public offering.’ More accurately, it is also shorthand for: It’s Probably Overpriced, Imaginary Profits Only, Insiders’ Private Opportunity, or Idiotic, Preposterous, and Outrageous.”

See the source image“I never ask if the market is going to go up or down because I don’t know, and besides, it doesn’t matter. I search nation after nation for stocks, asking: ‘Where is the one that is lowest-priced in relation to what I believe it is worth?’ Forty years of experience have taught me you can make money without ever knowing which way the market is going.”—Sir John Templeton

“Investing isn’t about beating others at their game. It’s about controlling yourself at your own game.” – Benjamin Graham

“Successful investing is about managing risk, not avoiding it.” – Benjamin Graham

References:

  1. https://cabotwealth.com/daily/value-investing/benjamin-graham-quotes-to-improve-your-investing-results/

Inflation…the Enemy of Savers

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Inflation is the enemy of those who save.

For most of the 21st century, savers and investors have experienced a favorable period of relative low inflation stock market growth. In fact, the average annual inflation rate from 2000 through 2021 was 2.31%. Even with that “low” inflation rate, the proverbial uninvested dollar hidden under one’s mattress in the year 2000 would be worth a mere $0.62 today.

With inflation approaching 7% in late 2021, we’re on the precipice of witnessing the rapid erosion in the value of the dollar which will create substantial risk for ordinary savers and ultra conservative investors. Keeping your money in a savings account, money market or CDs is failing to protect it from inflation.

Instead, the best place to invest is in the economy. While large sums of money are generally required to purchase real estate or a small business, the stock market allows those with limited capital a means to invest regularly in a wide variety of businesses and benefit from the strength of the economy.

The equity markets have a history of robust returns over the long run. Over the last one hundred years, the average annual stock market return is 10%. That means investors who stay invested are nearly doubling their investments every seven years.

Some individuals view the stock market as too risky and they literally view investing in the market as “gambling”. But, when you choose to use less “risky” investments like bonds rather than investing in stocks, the results vary great.

A study by NYU’s Stern School of Business gives insights into historical returns provided by an investment in U.S. Treasury bonds as opposed to corporate bonds and the S&P 500.

Assume an investor received a $300 inheritance on the day he was born. On that date, his parents invested $100 (the inflation-adjusted equivalent of $1,630 today) in several asset classes in 1928.

As of September of 2021, the above investor would have $8,920.90 in U.S. Treasury bonds, $53,736.50 from corporate bonds, and $592,868 in returns from an index fund that tracked the S&P 500.

Obviously, the stock market beats “safe” investments. While bonds might play an important role in a balanced portfolio, a 100% bond portfolio will fail to achieve the investment goals for most.

Investing a little now is better than a lot later

“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.” – Albert Einstein

A strong argument can be made that the amount of time one is in the market is of more importance than the sum invested in stocks.

Consistently timing the market is impossible. There literally is no human being who can claim that he or she has been successful at that task with any degree of honesty. However, timing the market is not only unachievable, attempting to time the market can lead to poor investment returns.

Over time, this would result in an ever-falling income stream. You spent your life buying stocks because they are a great source of return, that doesn’t stop just because you retire! The market is still the best source of future returns, you should be continuing to buy more, not sell!

If one largely invests in stocks with yields of 5% or more, you can receive a substantial annual income without cannibalizing your portfolio. Furthermore, if the average annual market return is 10%, a stock that yields in the high single digits does not need to appreciate markedly to provide market-beating returns.

Higher yield stocks outperform more often. They distribute cash on a recurring basis, whether share prices are up or down. Prices are volatile, and at the whims of emotional investors, dividends are the profit generated by the business and distributed to shareholders.

Any investor with an employer with matching contributions should take full advantage of that opportunity. Any investor with an employer with matching contributions should take full advantage of that opportunity.

By investing in dividend-bearing stocks and resisting the temptation to time the markets, you can be well on your way to building wealth and achieving financial freedom.

References:

  1. https://seekingalpha.com/article/4484316-retirement-what-novice-investors-must-know

The Ultimate Buy and Hold Strategy

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The Ultimate Buy and Hold Strategy is an extremely effective way to “beat the market” if you regard the S&P 500 as “the market.” Paul A. Merriman

For more than half a century, investors who held equal parts of the S&P 500 index funds and nine other equity asset classes could more than double their long-term returns — with surprisingly little additional risk, explains Paul A. Merriman, founder of investment-advisory firm Merriman Wealth Management..

Much of the additional investment return comes from adding value, small-cap and international stocks to the S&P 500 index portfolio. By itself, the S&P 500 index is a good investment. Since 1928, the worst 40-year period for the S&P 500 index was a compound annual growth rate of 8.9%; the best was 12.5%.

For the past 52 calendar years, from 1970 through 2021, the S&P 500 index has compounded at 11%. An initial investment of $100,000 in 1970 would have grown to $23.1 million by the end of 2021.

The Ultimate Buy and Hold Strategy is an extremely effective way to “beat the market” if you regard the S&P 500 index as “the market.” Instead of investing all your capital into a S&P 500 index fund, you diversify your money amongst a variety of index funds, as follows:

  • 10% into large-cap S&P 500 index stocks
  • 10% into large-cap value stocks
  • 10% into U.S. small-cap blend stocks
  • 10% into U.S. small-cap value stocks
  • 10% of the portfolio to four more important asset classes:
  • 10% into international large-cap blend stocks
  • 10% into international large-cap value stocks
  • 10% into international small-cap blend stocks
  • 10% international small-cap value stocks
  • 10% in emerging markets stocks

Index funds are exchange-traded fund (ETF) or mutual fund. ETFs and mutual funds that are pooled investments of stocks or bonds. They offer investors a highly diversified opportunity to invest in a specific index, sector, or a wide range of other portfolio compositions.

When it comes to index funds, these funds’ portfolios are constructed specifically to mimic the action seen in the underlying index. Index funds — in particular low-cost index funds — should have a place in just about anyone’s investment portfolio.

Ultimate portfolio requires owning and periodically rebalancing 10 component parts.

The “ultimate” all-equity portfolio automatically takes advantage of stock-market opportunities wherever the opportunities might be.

“A low-cost index fund is the most sensible equity investment for the great majority of investors. By periodically investing in an index fund, the know-nothing investor can actually out-perform most investment professionals.” Warren Buffett

References:

  1. https://www.marketwatch.com/story/this-investment-strategy-is-an-extremely-effective-way-to-beat-the-s-p-500-11645065209
  2. https://www.moneycrashers.com/warren-buffett-invest-index-funds/