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2 Important Investing Tips From Peter Lynch

By Bradley Freeman – Updated Oct 10, 2020 at 12:02PM

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Here's how this investing legend goes about picking a stock.

Peter Lynch is second to none in terms of investing role models to glean wisdom from. In 1977, Lynch took over the Fidelity Magellan Mutual Fund with $20 million in assets under management and grew it into a $13 billion fund by 1990, with annual returns of just under 30%.

He consistently beat market indexes, and did so in his own, unique way. Below are the two most important lessons Peter Lynch has offered the public over the years.

Woman thinking with colorful brain illustration and gears in background

Image source: Getty Images.

1. Know what you own

Lynch preaches that investors should always know everything there is to know about an investment. This seems simple enough, but public market liquidity makes it extremely easy to purchase a stake in a company before doing so. Don't.

This is your hard-earned money you are putting to work, so it makes sense to do your own research and develop your own conviction when deciding to invest. Lynch has a very simple test for determining if you have that coveted full understanding. To him, an investor should be able to entirely explain an investment to a fifth-grader quickly enough so that they do not get bored. This task is impossible unless you truly become an expert in any company you purchase.

Learning all of the ins and outs of a potential investment like Lynch urges us to do ensures you're able to comprehend a company's news flow. If you don't know a company's goals or long-term prospects, it's difficult to learn anything meaningful from a news release besides the company's short-term price action, which is an imperfect indicator at best.

One who has a firm handle on where an organization is and where it is trying to go can more easily size up a new event's effect on its future. How do you go about doing so? The beauty of public companies is that they must disclose how they're doing publicly. Information sources like earnings reports, interviews with executives, and industry data are more widely available today than ever. Those willing to look will be able to find all they need to find.

2. Prepare for volatility

According to Lynch, in the stock market the most important organ is the stomach, not the brain. He believes "the key to making money in stocks is to not get scared out of them" and that no investor needs more than "fourth-grade math" to succeed.

How could this be? In public markets, an investor can be extremely prepared, and extremely knowledgeable about a certain investment. If that investor cannot tune out inevitable bearish noise on a stock, long-term investing becomes more unrealistic and success further out of reach. In this light, the importance of discipline is higher than intelligence.

Looking back, for investors to enjoy outsized returns from some of the most successful public companies, they also had to grit their teeth through serious pullbacks. For example, both Apple and Amazon have experienced several 30%+ pullbacks on their way to trillion-dollar valuations and historically impressive returns. Ignoring that negative price action is much easier said than done. Several smart and prepared investors knew all they needed to know about Amazon and Apple. Still, they could not stomach such extreme volatility.

As Lynch teaches us, trusting your research is both challenging and imperative.

Be a better investor

Investing can be an intimidating activity when going about it alone. Learning from investing legends like Lynch can help make sense of sometimes seemingly random markets. Here we have my two favorite lessons from Peter Lynch -- both tips have helped me become a better investor and can do the same for you.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Bradley Freeman has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon and Apple and recommends the following options: short January 2022 $1940 calls on Amazon and long January 2022 $1920 calls on Amazon. The Motley Fool has a disclosure policy.

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