We often publish different investing philosophies espoused by guest writers. What follows is yet another argument for stock picking. This time, we bring to you a guest post by Joel Reese, from the stock investment site called WeSeed.com, where you can learn how the stock market works.
Several years ago, I had a little extra money in my pocket. I decided, “I think I should give this investing stuff a shot.” I did a little digging, then I got a can’t miss, sure thing, stone-cold-lock tip about a semiconductor company.
I blindly put an order in through my discount broker and bought into the stock at $48 per share. It went up to $60. Hey, I’m a genius! I thought. Then it dropped like a stone. It hasn’t broken $20 since.
Hey, I was young(ish) and foolish. Don’t do what I did.
That doesn’t mean you shouldn’t invest in individual stocks, even though a lot of people say you should stay far, far away. In his excellent book I Will Teach You to Be Rich, Ramit Sethi cites some imposing stats: Mutual fund managers beat the market a mere 25 percent of the time.
Sethi — the man behind the must-read blog IWillTeachYouToBeRich.com — insists that experts simply can’t guess which stocks will outperform the market. “If these experts — who devour annual reports and understand complicated balance sheets — can’t beat the market, what chance do you have of picking stocks that will go up?” He asks. “That’s why individual investors like you and me should not invest in individual stocks.”
But Sethi is buying into a fallacy about the market: that the guys in the mirror-glass buildings are the best ones to judge a stock. Yes, they have all the charts and balance sheets. Yes, they have the beautiful silk ties, impressive MBAs, and jaw-dropping salaries.
But there are some advantages to being a small investor: Peter Lynch notes in his epochal One Up on Wall Street that the best person to make a stock pick is… YOU. This is called the “street lag” theory.
“Under the current system, a stock isn’t truly attractive until a number of large institutions have recognized its suitability and an equal number of Wall Street analysts (the researchers who track the various industries and companies) have put it on the recommended list. With so many people waiting for others to make the first move, it’s amazing that anything gets bought.”
In other words, if you wait for a stock to make its way from Main Street to Wall Street, you’re already late to the party. If you make some good stock picks before Wall Street catches on, then you stand to make huge gains.
We’re not saying you should put all of your money in individual stocks: that would be fairly Evel Knievel-esque. You should start with index funds, but that’s another lesson entirely. Make sure you’ve got your basic portfolio down pat, then for the adventurous part of your portfolio, you can look into a little more stock picking if you are so inclined.
Image from BusinessWeek.com
Investing Like Peter Lynch: Strategies For Picking Stocks
Since we’re talking about Peter Lynch here, allow me to go over a bit of this investment guru’s background. Lynch got his undergraduate financial degree from Boston College and his MBA from the Wharton School of the University of Pennsylvania. He then proceeded to head the Fidelity Investments’ Magellan Fund in 1977, which catapulted him to investment rock start status. He’s shared his tips along the years, including:
- Be an expert on the stocks you pick or the industries you decide to invest in. That is, know what you buy and own, and be able to easily explain your investments. How confident and knowledgeable are you about your holdings?
- Don’t get too hung up or caught up in how interest rates and the economy are behaving or moving. I understand this to mean that we should create an “all weather portfolio” comprised of strong companies that can withstand any type of economy.
- Take your time to identify top notch companies and stocks. Spend enough time doing the research.
- Don’t take unnecessary risks with investments that may not pan out (even if they have higher returns). Don’t speculate or gamble.
- Know a company’s fundamentals and go for those with excellent management and solid financials.
- Be open to committing mistakes and learning from them. I believe that the best lessons that we learn are those from the mistakes we make.
- Don’t be complacent. Paranoia can be good for you.
So I’ve paraphrased Peter Lynch’s well known nuggets of wisdom, but I also thought to provide some steps to put his advice to good and practical use:
1. Start by amassing a little money. (The operative word there is “little.”) Sign up with a reputable online broker and begin by putting some money aside via an automatic deduction from your paycheck. Keep it in a cash account while you start to get comfortable in the world of stocks. Go for a discount broker that has the reputation and lower commissions. Look for a stock brokerage that’s very supportive of the small investor such as ShareBuilder, which actually has an automatic investing program that may work out for those who are looking for an affordable way to build a stock portfolio over time.
2. Check out a virtual trading platform to get a feel for investing and trading. Many investing sites and cheap brokers offer free investment resources. You can learn how the stock market works if you try paper trading first, regardless of whether you decide to become a long term investor (a wise approach) or a short term trader.
3. Try different investing strategies. If you’re comfortable with mutual fund investing already but would like to give the Peter Lynch strategy a shot as well, then look at companies that you know (keep in mind, though, that Lynch wasn’t just about which stores have long lines of customers: he’s big into earnings and P/E ratios, for starters). Most virtual trading sites are free, so go wild and try out several theories when you pick stocks and select what goes into your portfolio. Remember that mutual fund or index investing and stock picking are not mutually exclusive strategies.
So jump on in, but be forewarned: investing in stocks is far from a sure thing. As Lynch himself writes:
“People who succeed in the stock market also accept periodic losses… Calamitous drops do not scare them out of the game. If seven out of ten of my stocks perform as expected, I’m delighted. If six out of ten of my stocks perform as expected, then I’m thankful. Six out of ten is all it takes to produce an enviable record on Wall Street.”
Do you subscribe to Peter Lynch’s strategies?
Note that The Digerati Life advocates the “core and explore” methodology and an investment portfolio which is comprised of at least 90% index funds using asset allocation and diversification strategies, and at most 10% individual stocks and other assets that are purchased through market timing, stock picking or any experimental approach to investing.
Created December 10, 2009. Updated March 18, 2012. Copyright © 2012 The Digerati Life. All Rights Reserved.
{ 9 comments… read them below or add one }
Paper trading of course makes sense. Excited first times quickly jump to real money trading (gambling). That’s what happens.
John DeFlumeri Jr
I use Sharebuilder and I really like it. I also have a ROTH IRA thru Ameritrade. All your discount brokerage accounts are about the same. The main goal you should have is the cost of the trade – if you are paying more than about $15 look elsewhere.
As far as stock trading, I like investing in stocks. The thing to remember is discipline. I have a group of about 5-6 stocks that I follow, because that is about all I have time to monitor. I can tell you their movements for the last 2 years. I try to trade in the cycles and have done okay. Not getting rich, just some pocket change. I stick with reputable companies or ones that I feel have a good upside.
Paper trading might give you a ‘feel’ for investing but since it’s not YOUR real money you won’t get a sense of how you will really invest. Investing is largely emotion for most people. Can you withstand drops in your portfolio, if not you need to learn how to employ stop-loss trades.
For beginners Investopedia has a nice fake money stock simulator that I used before jumping into real trading.
That being said, back to the post. I do agree with Peter Lynch approach for beginner investors. I had a portfolio were 6 our 0f 10 of my position made me money. One of these positions was WYN which I purchased at $3 and now has earned me over a 300% gain, which significantly offset similar positions that were down 20 and 30 percent.
The key is to accumulate ‘some’ money and just start investing with money you can afford to lose. You can consider if you have to learn the hard way a cost to learn how to invest, most people learn from there mistakes. That being said, it’s hard to invest in individual stocks and accumulate a diversified portfolio, due to the fact that you wont have enough cash to purchase significant positions in 10 different companies involved in different and unrelated industries. If you’re investing approach is to be diversified, you would be better off investing in ETF’s and mutual funds.
I’ve found that the site Updown is a good way to experiment with stock trading with pretend money.
Yes, I do subscribe to Lynch’s advice, But with a Warren Buffet twist!
The advantage the small investor (like us) has is the size advantage! The mutual funds are managing millions of dollars, and they are limited as to how much of a company they can own. Not to mention that when they do trade, it’s not 100 shares at a time like we can do, it’s more like 10,000 shares during a few day span.
Warren Buffet, even said “I think I could make you 50% a year on $1 million. No, I know I could”.
So if you invest in what you know like Peter suggests, and study the financials like Buffet, you might have an advantage over the big mutual funds. Most people don’t have this discipling though (including me, at least not yet).
I think Peter Lynch’s book has got to be one of the greatest ever for individual investors. I am a small investor who believes in stock picking too. Even if someone doesn’t like stock picking, the book is definitely worth a read, and will give a great perspective on investing.
I’m very new to investing online, but I’ve not read Peter Lynch – from your post though it sounds like I’m missing out!
I would like to add something to number 1 (saving a little money for investing). I personally think that you should not go into stocks unless you have about $5,000 – $10,000 to risk. The minimum purchase for one stock should be at about a $2,000 trade, or else you’ll be ripped off.
The only reason for individual investors to try and pick stocks is as a proxy for gambling. You get some of the same rush but with better odds than Vegas. But analysts and fund managers have years of experience and full-time job focusing on a few stocks and they are still miserable at beating the market. Thinking that you can do it by part-timing is deeply delusional, regardless of whether you pattern yourself after Warren Buffett, Peter Lynch, Ralph Elliot or anybody else. But if you enjoy the game and stock-picking saves you an annual Vegas trip it might be a good “investment” on whole.