Peter Lynch's 10 Golden Rules of Investing

Introducing Peter Lynch to investors is like introducing Sachin Tendulkar to cricket fans. In short, he needs no introduction.

Peter Lynch is one of the most inspiring and successful investors of all time. He was the manager of Magellan Funds at Fidelity Investments from 1977 to 1990.

During these years, Peter Lynch was like the linchpin of Magellan Funds. The firm grew fast with Peter Lynch at its centre.

He retired at the age of 46.

46! That's four years short to even a half-century. By this age, most people can't even do retirement planning, let alone actually retire.

So, in the hopes of following his footsteps and becoming a billionaire, we bring to you the 10 golden pieces of advice from him.

#1 Investing is fun and exciting, but dangerous if you don't do any work

This advice is for all those who think investing in the stock market is some magic trick.

Many investors just copycat and invest in others' hard work and relax. They duplicate the work of investing gurus.

But if investing was that easy, then any Tom, Dick, and Harry would be a millionaire.

In fact, we hear more stories of losses than success in stock market. It is because investment is not just some haphazard selection of stocks based on wild guesses. This is speculating.

Investment is fun and exciting once the stock earns what you want but before that, it is all hard work. Selecting a company, studying it, and keeping daily track of it is no joke.

It is typically the case of "Savdhani hati, durghatna ghati." So, it is quick and exciting but by no means less demanding.

#2 Never invest in any idea you can't illustrate with a crayon

Have you met the owner of any business? Have you asked them how their business runs? A business owner will be able to tell you so easily how his business works.

He will paint a picture in front of you as if he was drawing with a crayon.

Investing in any company is equal to becoming an owner of that company. Hence, if you do not understand the business like an owner understands it, do not invest in it.

If you invest in a business that you don't understand, you will never know the true potential of the company.

#3 You can't see the future through a rear-view mirror

Assessing the past performance of a company is very important while investing in a company. Looking at the past trends will give you a complete idea of how the company has progressed.

Hence assessing past performance is a crucial yardstick. It is crucial, but it is not sufficient.

For example, imagine a company had an excellent growth rate so far, but in the past six months, there were many internal issues. There is a rumour, that the management will change in the next AGM.

Now, in this scenario, this company becomes a bad investment. No matter how bright the past performance, the future is dark if the new management is not capable!

Looking in the rear-view is important, but you have to look in the front too. If you do not look in the front, you will just keep looking for a car in the back. Suddenly you will get hit by a truck from the front.

#4 Nobody can predict interest rates, the future direction of the economy, or the stock market.

Dismiss all such forecasts and concentrate on what's actually happening to the companies in which you have invested

The economy is dynamic. One day when you sleep everything may be normal. But the next day when you wake up the economy may be standing under the threat of a world war!

So, the economy cannot be predicted. Economic factors are out of anybody's control, but a company's performance or factors can be predicted.

For example, parents can teach their kids to be strong. They cannot expect the world to go soft on their kids. But they can teach their kids how to face the world.

If they have taught the kid well, he may face problems initially but in the end, the kid will shine bright in the face of a cruel world.

Just like that, if you believe the company is fundamentally strong, do not pay attention to the forecast or predictions. If the company is good, it will stand tall even after withering the temporary storms.

A good company may shed leaves and fruits but, it will never be uprooted.

#5 The best stock to buy may be the one you already own

Once you buy a stock after a long and thoughtful process, do not keep looking for better investment opportunities.

Stock markets are large and complex. If you keep switching from one company to another just because the other company is giving better returns, you will end with no real profits.

Imagine you make a new friend because he speaks good French so that you can learn from him. You both become good friends in a week. But after a week, you find that your friend has a neighbour whose French is better than your friend's.

So you leave your friend and go to his neighbour. But when you go there you realise that his French is too tough to understand.

But now, you cannot go back to your old friend because you actually paid this neighbour to learn French.

You get trapped in similar situations when you always keep looking for better stocks. Once you have made your decision, trust it to work for you unless there are some fundamental changes in the company.

To decide how many stocks you should have in your portfolio, have a clear idea of the kind of stocks you'd like to pick. Then go ahead and invest in only those stocks.

#6 When insiders are buying, it's a good sign, unless they happen to be New England bankers

Charity begins at home.

Similarly, investment also begins at home. Suppose I want to start a new business and need capital of Rs 1 m. I come to you and ask for money.

No matter how good my business is or how profitable it may seem, your first question will be, "How much money are 'you' bringing in?"

If I do not trust the business to do well, why would anyone else trust me?

Similarly, the first question you should ask the company is "What is the promoter's holding in the company?"

The promoter's holding indicates the promoter's trust in the company. So if promoters are buying shares in the company, they either think that the shares are undervalued, or something big is about to happen in the company.

The comment from New England refers to the foolishness of the promoters of Texas and New England banks. They had a very high stake in their own banks even when they had no strategy for a turnaround of the share price. Ultimately, the bank had to close down.

#7 With small companies, you are better off to wait until they turn a profit before you invest

You love your parents and your kids equally. But you cannot deny the fact that your children are the ones who will look after you in the future even when your parents are alive.

The reason here is simple. Your kids are young. As they are standing on the cusp of youth, they have more energy to look after you.

Similarly, small companies can earn hefty returns for you as compared to large-cap companies. Small-cap companies are in the growth stage while large-cap companies are usually in the maturity stage. Hence, small-cap companies have a higher growth rate.

The problem in trusting your kids is that they may go wayward and may not look after you at all.

Similarly, with small companies, you never know whether companies will actually grow to the potential they exhibit. Instead of offering you growth, these companies may even take a swipe on the invested capital.

Hence you must give power to your kids only if they can guarantee they will listen to you. You can at least get some assurance by giving them limited access to your property.

On the same lines, you should invest in only those small-cap companies that already generate profit. The business idea and management may be excellent, but they are useless if they cannot generate a profit.

If these companies cannot make a profit in the early stage, how will they survive future challenges? Hence, one must only invest in small-cap companies once they can generate actual profits and not just project profits.

#8 A stock market decline is as routine as a January blizzard in Colorado. If you're prepared, it can't hurt you. A decline is a great opportunity to pick up the bargains left behind by investors who are fleeing the storm in panic.

You can't live in a house by the beach and expect that waves won't enter your house. If you want the view, you got to deal with the water.

In share markets, if you want hefty returns, you got to deal with the risk of downfall too. Share markets are cyclical. Hence the fall is inevitable.

So, when a fall is inevitable, one should be prepared for the fall. One cannot predict when the share market will fall but, one can plan his investments.

While investing, an investor should study and plan meticulously to earn hefty returns. But he must also be prepared, that these returns might not come within the expected time horizon if the economy goes under major changes.

The reds of the share market should not be seen as a warning sign. They should be seen as an opportunity to invest. That is, the company has good prospects and is fundamentally strong.

Falling stock markets should be seen as an opportunity. It is an opportunity to buy the best stocks at a discounted price because majority of the crowd is selling those stocks.

#9 If you can't find any companies that you think are attractive, put your money in the bank until you discover some

Imagine you have to hire an IT manager for your company. You need very skilled personnel.

When you roll out the hiring process, you realise that there are two kinds of issues. One, most people coming for interviews do not have the required skill set.

Two, those who have the required skillset are charging way higher than the normal industry rate.

What do you do in this situation? You look for different means of hiring people. Simultaneously, you try to manage however you can until you find the right person for the job.

An investor should behave in the same way while investing in stocks. After all, buying a stock is like hiring a company to work for you.

So at times, you see that either the company is not meeting your expected growth standard or prospects.

Or that the shares are overpriced compared growth potential.

You must wait in these cases.

If you cannot find the right stock to earn for you, put your money in the bank until you find that right stock. Do not have this blind need to forcefully invest in stock even when it does not fit your growth criteria.

Knowing 'when NOT to buy a stock' is something that all investors should know.

#10 Owning stocks is like having children. Don't get involved with more than you can handle

Having a diversified portfolio reduces the overall risk of your portfolio. When you have a diversified portfolio, the external factors won't affect all stocks at the same time. Hence, losses will be reduced.

But if you have too many stocks in your portfolio, you will have a difficult time trying to keep track of all the stocks. Two stocks may be soaring, while the others may be plunging, and three more may be range bound.

Now all these stocks require different actions. So unless you can handle too many stocks, going in too many different directions, hold your horses.

Peter Lynch says a portfolio with five stocks is more than enough.

Stocks are like children. You have to constantly look after them. The irony is that even when you are looking after them, you have no guarantee they will not go wayward.

Hence, get involved with kids and stocks up on a number you can handle!

Final words

If any person wishes to earn through share markets over a long period, he should keep these ten lessons in mind.

Make a detailed study of these points and gains will automatically follow. Let multibagger stocks come to you. Of course, studying a company, management, and its future is tough and tedious.

But good things don't come easy and they take time, right?

To know more about investing stay tuned to Equitymaster.

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. Learn more about our recommendation services here...