Peter Lynch's 2 Key Tips for Young Investors

One of the greatest advantages a young investor has is time. Investing legend Peter Lynch, who saw average annual returns of 29% during his tenure managing Fidelity's Magellan fund from 1977 to 1990, encourages all investors to start investing young by saving money in a retirement account. The advantage of putting your money into a retirement fund, explains Lynch, is allowing the miracle of compound interest to occur without paying taxes. "Start saving early," says Lynch, "and the numbers are amazing."

If you start by investing $1,200 in the stock market every year and gain an average of 9% annually -- the stock market's historical average annual return -- your portfolio would grow to a total of $121,136 after 25 years. If you continued investing $1,200 annually and earning 9% each year for another 15 years -- adding new money to your investments for a total of 40 years -- your total portfolio would be worth $479,642. 

Time is clearly on the side of younger investors. The above example demonstrates why Peter Lynch suggests you start saving and investing in a retirement account now. Starting to add funds to a Roth IRA at age 20, versus waiting until you are 30 or 35 years old, could mean a difference of hundreds of thousands (or even millions) of dollars by the time you retire. The longer you wait to start saving for retirement, the bigger a financial hole you're digging yourself.

Invest in what you know
In addition to time, younger investors should make use of Peter Lynch's "invest in what you know" philosophy. "The worst thing you can do," contends Lynch, "is invest in companies you know nothing about." 

The greatest investments are often right in front of us throughout our daily lives. I became a student at Berea College in 2010 and will graduate in May. Looking back on my experiences over the past four years, I now realize how many great investments were right in front of me all along. Let me explain. 

When I first came to Berea in August 2010, I signed up for Amazon.com's (NASDAQ: AMZN  ) Amazon Student service. This service gives students the opportunity to receive free two-day shipping on a wide variety of products for dorm rooms, classes, and other college essentials. Jeff Bezos' innovative leadership has helped Amazon expand sales at an average annual rate of 21.46% since 2010 to $74.5 billion in 2013. Amazon's operating cash-flow production increased at an average pace of 11.9% annually since 2010, giving Bezos and company the firepower to continue Amazon's innovative streak.

Investors have been amply rewarded by the stellar performance of Amazon, with the stock increasing 148% since I began using Amazon Student as a college freshman in 2010, far outpacing the S&P 500's 66% gain over the same period.  

Fast-forward to the summer of 2012, between my sophomore and junior years of college. I was participating in an intensive summer social entrepreneurship program in Appalachia, exploring the thriving towns of western North Carolina and the comparatively struggling counties of Eastern Kentucky. In particular, my classmates and I focused on how social-media customer review websites, such as Yelp  (NYSE: YELP  ) , could put businesses in Eastern Kentucky on the radar for tourists. 

Since the summer of 2012, the S&P 500 has increased by 33%. Yelp's stock, it turns out, has increased 319%. Since 2011, Yelp has grown sales at an average annual rate of 67.3% while seeing cumulative customer reviews increase 46% annually over the same period to 53 million in 2013. Yelp's ability to consistently attract users -- and generate impressive sales growth from those users -- has handily rewarded investors with market-beating returns over the past several years. 

In February 2013, I attended a college workshop on how to effectively use LinkedIn  (NYSE: LNKD  ) as a platform to market job skills and boost my chances in the job hunt scramble. I set up my LinkedIn profile, but foolishly (with a small "F") did not consider researching the business as a potential investment. Had I delved deeper into LinkedIn, I would have found a rapidly growing business guided by Jeff Weiner, a young and visionary leader. Since 2010, LinkedIn has grown its base of cumulative registered members from 90.43 million to 276.84 million in 2013 while increasing operating cash flow an average of 43.19% annually and sales 58.35% annually since 2010. 

LinkedIn stock has increased 55% in value since I started my LinkedIn profile in early 2013. The S&P 500 increased 21% over the same time frame. Starting to get the idea?

The greatest long-term investment returns will often be generated by the businesses creating and offering the products and services we use in our daily lives. Of course, not every business whose products you use will be a great investment, but simply looking around you is a good way to start considering investment opportunities. Start by researching the businesses behind the products you and your friends know, use, and love. Younger investors are in a particularly apt position to spot up-and-coming trends and potentially stellar investments.

Foolish final thoughts 
Whether you are a new or experienced investor, it's wise to take the words of investing greats like Peter Lynch seriously. Warren Buffett similarly encourages parents to teach their children the importance of saving money at an early age.

Young investors have more time on their side for compound interest to accelerate their returns. Young investors can also capitalize on their knowledge of consumer trends, as well as new and popular products, to help spot potentially rewarding long-term investment opportunities. Start investing today, explore and invest in what you know, and practice patience as you build a sound retirement portfolio over the long haul.

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Editor's note: A previous version of this article listed Amazon's 2013 sales as $74.5 million instead of $74.5 billion. The Fool regrets the error.


Read/Post Comments (12) | Recommend This Article (29)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 12, 2014, at 10:54 AM, gorlickg wrote:

    Come on. Be real. Why give "9 percent every year " as the baseline? Impossible metric? Sounds like the insurance company touts!! It's unfair and cruel. IMHO

    Cyborg 1939

  • Report this Comment On March 12, 2014, at 11:31 AM, KingOfPizza wrote:

    Don't forget that young people should consider investing extra in a down market. The numbers are on your side when you have 30 years to let it ride.

  • Report this Comment On March 12, 2014, at 12:12 PM, XXF wrote:

    Psst, intern - I'm pretty sure Amazon has more than 74 million dollars of sales in 2013 and pick one number of significant figures for your article and stick with it, rather than going out to hundredths of a percent for one metric then cutting off everything after the decimal for another metric. Accuracy and consistency are both important.

  • Report this Comment On March 12, 2014, at 5:57 PM, Sumflow wrote:

    Sure investing longer has greater potential than sooner. But there are many short term cash flow problems that can be dealt with easier, if you do not tie up your funds in sheltered retirement trusts.

    It does not matter if you are a kid. If you have thirty years left at 60, your returns will be the same as a kid who's ancestors usually don''t make 50.

    "Save by borrowing," can help at the beginning.

  • Report this Comment On March 13, 2014, at 11:48 AM, TMFPencils wrote:

    XXF -- Amazon had $74 billion sales in 2013, as I stated in the article (not $74 million).

    Fool on!

    David K

  • Report this Comment On March 14, 2014, at 2:36 PM, SayWhat31709 wrote:

    Thank you guys for your advice, wow i so wish we knew this before,

  • Report this Comment On March 15, 2014, at 7:57 AM, WimvanderLoo wrote:

    An average return of 9% isn't the same as a return of 9% every year. If you make 8% one year and 10% the other, your total return will be less than when you earn 9% two years in a row. A more extreme example: if one year you earn 118% and the next you lose 100%, your average gain is 9%, but you have nothing left.

    So Peter Lynch's reasoning is overestimating the effect of interest over interest..

  • Report this Comment On March 15, 2014, at 8:53 AM, SuntanIronMan wrote:

    @WimvanderLoo

    Yes, if you use an arithmetic average, you get overstatements like that. But stock market returns aren't measured in arithmetic averages. They are measured in geometric averages. And if you use a geometric average, you indeed get a -100% average return in your example.

    [(1 + 118%)x(1 + -100%)^ 1/2] -1 = -100%

    I really hope I'm remembering that formula correctly, haha. Someone please correct me if I did indeed type that wrong.

    Either way, it is -100%.

  • Report this Comment On March 16, 2014, at 12:30 PM, oakhut wrote:

    I agree in general the concept of starting investing young, I want to make following corrections:

    Investing $1200 a year at the beginning of each year, at 9% return, in 25 years will be $110,788 not $121,136, in 40 years will be $441,950, not $479,642.

    Second 7%, instead of 9%, would be more realistic long term annual market return.

  • Report this Comment On March 31, 2014, at 12:08 AM, vidar712 wrote:

    $441,950 forty years from now would only have the same purchasing power as $140,000 today (assuming constant 3% annual inflation.)

    Only someone who expects to die very soon or has a very low (but healthy) standard of living, could retire on that amount of money.

    This makes saving now even more important. Inflation will occur whether you save for retirement or not.

    When you are calculating how much money you will need in retirement, with time horizons of 30 to 40 years, make sure you adjust for inflation. With such a long time horizon 3% will have a significant impact on your target amount (think triple your goal amount).

    Good luck.

  • Report this Comment On March 31, 2014, at 3:18 AM, Interventizio wrote:

    Right anybody talks about the power of time, but nobody talks about the negative power of time: inflation. The truth is, the sooner you make money, the better. But that's when things begin to become risky, and so you are stuck with the strategy of waiting until you're old, you have less energy to enjoy the money you've made and inflation will have bitten off a big chunk of your gains. But what are you gonna do.

  • Report this Comment On March 31, 2014, at 9:14 AM, Mathman6577 wrote:

    I think the best way to say it is that the S&P500 has had a "compounded" (not geometric "average") annual return of 9% every year since 1960, including reinvesting dividends and stock splits.

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