Peter Lynch is one of the greatest fund managers ever. Though it’s been over two decades since he managed money, the lessons he learned are timeless. Lynch ran the Fidelity Magellan Fund from 1977 to 1990 – and beat the pants off the market. He outpaced the S&P 500 in 11 out of 13 years, averaging a 29% annual return. From start to finish, that’s a 2,700% return! If you invested as little as $37,000 with him in 1977, you were a millionaire in 1990. Fortunately for us, he’s willing to share his secrets. To achieve his stunning track record,…
Peter Lynch is one of the greatest fund managers ever. Though it’s been over two decades since he managed money, the lessons he learned are timeless.
Lynch ran the Fidelity Magellan Fund from 1977 to 1990 – and beat the pants off the market. He outpaced the S&P 500 in 11 out of 13 years, averaging a 29% annual return. From start to finish, that’s a 2,700% return! If you invested as little as $37,000 with him in 1977, you were a millionaire in 1990.
Fortunately for us, he’s willing to share his secrets. To achieve his stunning track record, he clung to nine simple principles. Here they are.
Know what you own
It seems elementary. But as someone who talks to lots of investors, I can report that you’d be shocked at how few of them actually do their research. They buy a stock because they shop at a certain store or buy a product. They don’t know what’s going on inside the company.
Lynch said, “Never invest in any idea you can’t illustrate with a crayon.” If you can’t explain what a company does, you shouldn’t own it. You can say the same about mutual funds, annuities, life insurance, and other financial products. Should you put money into something when you don’t fully understand how it works?
2. It’s futile to predict the economy and interest rates (so don’t waste time trying)
We financial types do enjoy watercooler talk about interest rates, trade deficits, debt levels, etc. But there’s a danger in converting thought into action. The world economy is an extraordinarily complex system, with over 7 billion people acting in their own self-interest and responding to each other’s actions, government incentives, and external shocks.
Trying to time the market is futile. Set up a financial plan that allocates your assets based on your risk tolerance, so that you can sleep at night.
3. You have plenty of time to identify and recognize exceptional companies
Lynch mentions that Wal-Mart was a 10-bagger — i.e., its stock rose to 10 times its initial price — 10 years after it went public. But even if you had gotten in after waiting out that first decade, you’d be sitting on a 100-bagger today.
Some would argue that it’s still not too late to get in on Wal-Mart, decades after going public. While the company’s no longer a monster growth story, it continues to crank out 20% returns on equity year after year. That type of consistent ROE is a huge positive indicator of management’s ability to effectively allocate capital.
You don’t need to immediately jump into the hot stock you just heard about. There’s plenty of time to do your research first.
4. Go for a business that any idiot can run
Good management is very important; a good business matters more … because sooner or later, any idiot is probably going to run it. A good business will do great under good management, but without it, the business will still be good enough to get by until new good management is found.
5. Be flexible and humble, and learn from mistakes
Lynch has said: “In this business, if you’re good, you’re right six times out of 10. You’re never going to be right nine times out of 10.”
Every great investor I’ve come across owns their mistakes. They focus as much time, if not more, studying their mistakes as they do their successes. Every investment they make has a theory behind it.
Whether they make money or not, they ask: “Why was my theory right or wrong?” Knowing what went wrong can ensure that you don’t repeat the same mistakes
6. There’s always something to worry about
Lynch noted that investors made a killing in the 1950s despite the new and very real threat of nuclear war. There are plenty of fears to choose from right now, but we’ve survived a Great Depression, two world wars, an oil crisis, and double-digit inflation.
Always remember that if our worst fears come true, we’ll have a heck of a lot more to worry about than some stock market losses. You can wait for the sky to fall, or you can invest knowing it will happen, you’ll get through it, and the market will, too.
7. If you need the money, don’t invest in stocks
Lynch was straightforward about not taking chances in the short term with money you can’t afford to lose. You should keep any money you might need in the next two or three years in cash or other low-risk investments. Stay away from the quick-buck mentality and stick with investing for the long term.
8. Don’t force yourself into one investment style
Lynch is best known for a strategy called GARP (growth at a reasonable price). His real investment style was flexible enough to adapt to whatever was going on in the market.
He understood that markets are cyclical, and styles go in and out of favour. (A style goes out of favour once everyone jumps on the bandwagon, and in favour once the last person gets off.) Instead, Lynch broke stocks into six categories or stories, turning to each at different points in the market cycle.
Once you’re married to one style, you’re stuck, sometimes waiting years before it comes back in favour. That requires a lot more patience than most of us have.
9. Avoid catching the bottom on a falling stock
It’s like trying to catch a falling knife. Stocks fall for a reason. Find out why. Sometimes management fixes the problem and the stock recovers. Oftentimes, they don’t.
Lynch was great at finding these turnaround stories, but he warns that management will always tell a great story. Stocks of bad companies will fall further when the story ends up being a fairy tale. It’s better to wait until a company has proven itself, and the stock has turned, before buying.
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Disclosure: Hayes Chan, CFA, is The Motley Fool Hong Kong’s investment analyst. Motley Fool Hong Kong is not licensed by the Hong Kong Securities and Futures Commission to carry out any regulated activities under the Securities and Futures Ordinance. Follow The Motley Fool Hong Kong on Twitter.