Peter Lynch, along with Warren Buffett, is one of the worlds most

Biographical Information

Peter Lynch, along with Warren Buffett, is one of the worlds most famous and successful value investors. He became famous as the manager of the Fidelity Magellan fund, which he built from a small, $18 million mutual fund, into a massive $14 billion fund. His average annual return on investment during the 13 years he ran the fund was 29.3%, providing a return of 28 times on every dollar invested in 1977 when he took over the fund.

Investment Strategy

Given Mr. Lynch’s history, it should be no surprise that he recommends investing in stocks for the long term. Most of Lynch’s published investing advice is simple common sense:

• Save as much money as you can and live below your means to assure that you will save.
• Buy a house before you start trying to get rich in the stock market.
• Start saving early and allow compound gains to make you rich. He recommends a 20-year investment time frame.
• Have a plan and stick with it. Do not let the day-to-day fluctuations of the market affect your investment decisions. Lynch is dismissive of “market timers.”
• If you do buy common stocks, make sure you understand the company and have a reason to believe that it is going to grow and have larger profits in the future. You should visit the company’s retail outlets (if any), read reviews of its products, check to make sure it has stable management, and talk to people who are the company’s natural customers.
• Spend at least one hour per week researching companies, including companies that you already own stock in, to make sure you still want to own the stock. In his books, Lynch provides a number of signals that tell you when it is time to sell a stock you own.
• If an unexpected drop in a stock price would have a dramatic impact on your lifestyle over the next few years, you have invested too much money in that stock.
• Companies with no debt cannot go bankrupt.
• Do not pay too much attention to market prognosticators. Lynch does not know of any market seers who have been right more than once (see survivorship bias).
• Market declines are the best time to invest in companies you like. (Warren Buffett feels the same way.)
• Invest in common stocks or stock mutual funds rather than in bond funds, commodities, or esoteric financial products you do not clearly understand.
• Avoid hot stocks in hot industries, and note that long-shots almost never win (hence the term “long shot”).
• Some portfolio diversification is good. Three to ten stocks in a small portfolio should be the minimum diversification you should try to achieve.
• If you do not have time to devote to researching companies, then invest in mutual funds and let professionals choose your investments. It is unwise to spend more time selecting a summer vacation destination than deciding where your retirement savings will be invested. However, most people spend days every year researching resorts, and only fifteen minutes making 401(k) decisions.
• Look for mutual funds with no loads (no money charges to invest) and low expense ratios.

Money Managers versus Average Investors

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Besides this common sense advice, the thing that made Lynch justifiably famous (other than the 29% average annual return in the Magellan Fund during the 13 years he ran it) was his insight that regular investors have a significant advantage over professional money managers. Lynch points out that money managers tend to be much the same. That is, they all read the same newspapers, follow the same general strategies, and invest in the same stocks. In fact, professional money managers are mostly encouraged to provide average performance. The only reason they may be fired from their million-dollar-a-year-income jobs is underperformance relative to the average of their industry.

The average investor, on the other hand, is exposed to many potential investments that Wall Street professionals may not see until long after the company is hugely successful. Schoolteachers are constantly exposed to the latest teen fashions. Engineers know who is making the best products in their field. Wal-mart and Home Depot both started a long way from Wall Street. Consequently, people who lived in Bentonville, Arkansas, and Atlanta, Georgia, respectively, had the first opportunity to invest in those future large companies.

Peter Lynch is one of the most successful investors in history and most of his advice is timeless. However, his great success at Magellan took place in a different era (the late 1970s and 1980s) and we live in different times. Recent thinking holds that

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-- homeownership (which tends to lock homeowners into one geographic location) is not right for everyone,

-- actively managed mutual funds tend to under perform versus passively managed index funds, and

-- bonds may in fact out perform stocks over long periods of time.

However, if you can identify the next Peter Lynch in the vast crowd of professional money managers, then that is where you want to put your money.

Additional Resources:

• “One Up On Wall Street: How To Use What You Already Know To Make Money In The Market” by Peter Lynch and John Rothchild, Fireside, 1989.

• “Beating the Street” by Peter Lynch and John Rothchild, Fireside, 1993.

• “Learn to Earn: A Beginner's Guide to the Basics of Investing and Business” by Peter Lynch and John Rothchild, Fireside, 1995.

• “Interview with Peter Lynch”: http://www.pbs.org/wgbh/pages/frontline/shows/betting/pros/lynch.html.