Peter Lynch is one of the best stock market investors of all time. He managed the Magellan Fund between 1977 and 1990 and achieved extraordinary returns of 29% per annum, making it the best 20-year return of any American mutual fund over that period. I recently read his book titled “One up on Wall Street” and have outlined three key takeaways from the book. For anyone looking for a great read on investing in the sharemarket, I highly recommend the book.
1) You don’t need to make money on every stock you pick. In Lynch’s experience, six out of ten winners in a portfolio can produce a satisfying result. Why is this? Your losses are limited to the amount you invest in each stock (i.e. it can’t go lower than zero), while your gains have no absolute limit. Invest $1,000 in a dud company and in the worst case, maybe you lose $1,000. Invest $1,000 in a high achiever, and you could make $10,000, $15,000, $20,000 over several years. All you need for a lifetime of successful investing is a few big winners, and the pluses from those will overwhelm the minuses from the stocks that don’t work out. For example, if you invested $1,000 in REA Group Limited (ASX:REA) 10 years ago, that investment would now be worth over $50,000 and would more than cover a few poor investments in your portfolio.
2) Don’t try and forecast where the stock market is heading based on economic predictions. Since the stock market is in some way related to the general economy, one way that people try to outguess the market is to predict inflation and recessions, booms and busts, and the direction of interest rates. No one can consistently predict where the economy is heading. There are 60,000 economists in the US, many of them trying to forecast recessions and interest rates, and if they could do it successfully twice in a row, they would all be millionaires by now and retired. But as far as I know, most of them are still gainfully employed, which ought to tell us something. Invest in quality businesses and don’t try and forecast where the market is heading.
3) Stop listening to professionals. The amateur investor has numerous built-in advantages that, if exploited, should result in him or her outperforming the experts, and also the market in general. Lynch makes the point that one of these advantages is that an individual investor has better sources and they are all around you. If you stay alert, you can pick the spectacular businesses right from your place of employment or in your local shopping centre, and long before the mutual funds and professional investors discover them.
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Motley Fool contributor Bradley Murphy does not own shares in any company mentioned in this article.