Peter Lynch's #1 Rule for Investing Success

I frankly think it's a tragedy in America that the small investor has been convinced by the media, the print media, the radio, the television media, that they don't have a chance. They don't. The big institutions, with all their computers and all their degrees and all their money, have all the edges, and it just isn't true at all.

So that right there is Peter Lynch. He's one of the world's best investors, and he ran the Fidelity Magellan Fund between 1977 and 1990, where he averaged 29.2% annually over that 13-year period. So he is a phenomenally successful investor. You may also know him; he is the author, of course, of a very famous stock market book called "One Up on Wall Street."

As that first clip suggests, Peter Lynch is definitely an advocate of the small investor. He's actually the one that taught me that as a small investor, a retail investor, you actually have heaps of advantages over the big institutional investors. For example, no pressure from outside investors, being nimble in the stock market, being able to get in and out of positions basically whenever we want, and also having no pressure. Like, we can hold stocks for an ultra long period of time with no pressure on us to perform.

These are all very big advantages of the small retail investor that most people don't even realize they have. But one thing that has always bothered Peter Lynch is that most small retail investors do terribly despite having all of these advantages, where they should be able to outperform the big dogs. Above all else, there is one main reason for this, and it's a point that Peter Lynch has been talking about for decades: The single most important thing to me in the stock market for anyone is to know what you own.

I'm amazed how many people own stocks they would not be able to tell you why they own it. They couldn't say in a minute or less why they own it. No, actually, if you really press them down, they'd say the reason I own this is the sucker's going up, and that's the only reason. That's the only reason they own it. If you can't explain—I'm serious—you can't explain to a ten-year-old in two minutes or less why you own a stock, you shouldn't own it. And that's true, I think, about 80 percent of people that own stocks.

This is the kind of stock people like to own; this is the kind of company people adore owning. It's a relatively simple company. They make a very narrow, easy-to-understand product. They make a one megabit SRAM CMOS bipolar RISC floating point data I/O array processor with an optimizing compiler, a 16 dual port memory, a double diffused metal oxide semiconductor monolithic logic chip for the plasma matrix vacuum fluorescent display.

It has a 16 bit dual memory, it has a UNIX operating system for Whetstone megaflop poly-silicon emitter, a high bandwidth—that's very important—six gigahertz double metallization communication protocol, and asynchronous backward compatibility peripheral bus architecture, four wave interleaved memory, a token ring interchange backplane, and a dozen 15 nanoseconds of capability.

Now, if you own a piece of crap like that, you will never make money. Never. Somebody will come along with more Whetstones or less Whetstones or a bigger megaflop or a smaller megaflop. You won't have the farthest idea what's happening, and people buy this junk all the time.

This is a really good example of what most small investors do in the stock market. They think it's a complicated place, so they over-complicate it for themselves. They want to get in on these very complicated businesses that are on the forefront of technology, in the forefront of innovation, which is totally fine.

But oftentimes they do that when they don't actually understand what they're getting into. And Peter uses humor really well in this clip, talking about what happens when the next company comes along with more Whetstones or less Whetstones. What are you going to do about your investment? I don't know.

But it's important to realize one thing; that's important to remember is that it doesn't need to be this complicated. If you just look for simple businesses that you can understand, I made money in Dunkin' Donuts. I could understand it. When there were recessions, I didn't have to worry about what was happening. I could go there, and people were still there.

I didn't have to worry about low-price Korean imports. I mean, I just didn't know, you know, I can understand it. And you laugh, I made 10 or 15 times my money in Dunkin' Donuts. Those are the kinds of stocks I can understand. If you don't understand it, it doesn't work.

This is the single biggest principle, and it bothers me that people are very careful with their money. The public, when they buy a refrigerator, they've got Consumer Reports. They buy a microwave oven; they do that. They ask people, what's the best kind of radar range, what kind of car to buy. They do research on apartments. When they go on a trip to Wyoming, they get the mobile travel guide. Or California, when they go to Europe, they get the Michelin travel guide.

People will hear a tip on the bus on some stock, and they'll put half their life savings in it before sunset, and they wonder why they lose money in the stock market. And when they lose money, they blame it on the institutions in program trading—that is garbage. They didn't do any research. They put a piece of junk. They didn't look at the balance sheet, and that's what you get for it.

How true is that? People do hours and hours of research on like what laptop to buy—a big investment, you know, new laptop. They look up all the specs and whatnot, but then they'll go to the footy, or they'll go to the pub, and, you know, Jono told me about this really hot stock that he's bought, and it's gone up 10%. So, you know, I'll dump a couple of thousand dollars into that stock as well.

And unfortunately, I wish I could laugh, but this one it hits pretty close to home because when I first started out investing, I have an exact example of this for me. The example for me was at the time I was going in to buy a new computer, and I spent so, so long learning about computers, all of the different components and making sure they're all compatible with each other and if they're going to work well with each other.

I ended up building this PC. It cost me like $2,000 at the time. It had an Intel i7 processor, which was really speedy. You know, I had the NVIDIA GTX 560 graphics card, which was like, oh, really at the forefront at the time. I had a one terabyte HDD—a one terabyte hard drive—wow. That was just, you would never need that amount of space on a computer, but I got it anyway.

Anyway, I spent about two thousand dollars on this computer, and around about the same time, I was big into just like reading Motley Fool articles, and I remember reading like five Motley Fool articles that talked about this one stock in a positive light. So, I sunk about two thousand dollars into this stock. I mean, how crazy is that?

I spent all of what, an afternoon just researching this one stock, really. I didn't even research; I was just looking at these Motley Fool articles. And on the flip side, I would spend days and days—actually, I probably spent weeks—learning about computers to be able to effectively build this PC and spend as little on it as possible.

That's just stupid. And you won't be surprised to hear at all that that investment that I made way back when did absolutely terribly. So like, number one rule of investing: know what you own. Take the time to understand the company that you are putting your hard-earned money into. Stocks are not lottery tickets. There's a company behind every stock. If a company does well, the stock does well. It's not that complicated.

People get too carried away. Another key element is that you have plenty of time. Give her an unbelievable rush to buy a stock. I'll give an example of a well-known company: Walmart. Walmart went public in October of 1970. 1970 went public, already had a great record. It had 15 years performance, great balance sheet. You could have waited ten years saying you're a very conservative investor. You're not sure this Walmart can make it. You want to check. You see them operating in small towns; you're afraid they can only make it in seven or eight states. You want to wait till they go to more states— you keep waiting.

You could have bought Walmart ten years after they went public and made 35 times your money. If you bought it when they went public, you would have made 500 times your money. But you can wait ten years after Walmart went public and made over 30 times your money. You could wait three years after Microsoft went public and made ten times your money.

Now, if you knew something about software—I know nothing about software. If you know something about software, you would say, these guys have it. I don't care who's going to win: Compaq, IBM. I don't know who's going to win, Japanese computers. I know Microsoft MS-DOS is the right thing. You could buy Microsoft. Again, I'm repeating myself: stocks are not a lottery ticket. There's a company behind every stock, and you can just watch it.

You have plenty of time. People are in an amazing rush to purchase the security; they're out of breath when they call up. You don't need to do this. So Peter Lynch's number one rule is definitely to know what you own. But a lot of the reason why people end up owning stocks they don't understand is because they rush.

So, I'm really glad that Peter brings up this point in this talk. If you want to be a really successful investor, then just don't rush. You know, great companies are still going to be great companies in three to six months from now. Okay? Don't succumb to the fear of missing out as you are just starting to research a stock.

Okay, you take it from like any investor; take it from me, take it from any investor. It's a much, much better strategy to wait on the sidelines while you're researching a company than to start the process by investing in the company and then do your due diligence after the fact.

So take it from Peter Lynch: take your time, don't rush, and make sure you understand what you're buying before you buy it. All right, this last clip I want to show you is talking about how to actually go about building a stock portfolio where you do know what you own. You need an edge to make money, too. People have incredible edges, and they throw them away.

I'll give you a quick example of SmithKline. This is a stock that had Tagamet. Now, you didn't have to buy SmithKline when Tagamet was doing critical trials. You don't have to buy SmithKline when Tagamet was talked about in the New England Journal of Medicine or the British version, Lancet. You could have bought SmithKline when Tagamet first came out. A year after it came out, let's say your spouse, your mother, your father, you're a nurse, you're a doctor, you're writing all these prescriptions.

Tagamet was doing an amazing job of curing ulcers, and it was a wonderful pill for the company because if you just stopped taking it, the ulcer came back. See, it was a wooden crummy product that you took it for a buck, and it went away. But it was a great product for the company. But you could have bought it two years after the product was on the market and made five or six times your money.

I mean, all the doctors, all the nurses, all the people, millions of people saw this product, and they're out buying oil companies, you know, or drilling rigs. You know, it happens. So you only need a few stocks in your lifetime. They're in your industry.

I think of people; if you've worked in the auto industry—let's say you're an auto dealer—the last ten years you would've seen Chrysler come up with a minivan. You've seen, if you're a Buick dealer, a Toyota dealer, a Honda dealer, you would have seen the Chrysler dealership packed with people. You could have made ten times your money on Chrysler a year after the minivan came out.

Ford introduces the Taurus/Sable—the most successful line of cars in the last 20 years. Ford went up seven-fold on the Taurus/Sable. So if you're a car dealer, you only need to buy a few stocks every decade. When your lifetime's over, you don't need a lot of five-baggers to make a lot of money starting with ten thousand dollars or five thousand dollars.

So, in your own industry, you're going to see a lot of stocks, and that's what bothers me. There are good stocks out there looking for you, and people just aren't listening, and they're just not watching it. And this all circles back to say it with me: the circle of competence.

Right? The best way you're going to know what you own is to stay focused on companies that you bump into on a daily or a weekly basis. You know what industry you work in, what devices you use, what websites you browse, what meals you buy, what movies you watch, and so on. You don't realize it, but you already know a lot about a lot of companies.

So stay within your circle of competence. Stay around those companies where you have an edge. Say you watch a hell of a lot of TV; you've seen every TV series under the sun, and you know that, for example, Netflix's library is much, much better than what's offered on Disney Plus or on Prime Video. That's your edge.

Say you work as an accountant, right? You've just switched to a different accounting software, and this new accounting software is like ten times better than that old accounting software that you used to use—that's like the industry standard. There's an edge.

Say you work in construction, and you notice that there's this one company that has like twice as many projects on the go as all the other companies. Well, again, there's your edge. And it's crazy, as Peter Lynch says in this clip, it's like these people are out there buying oil companies. It's just buying stuff that they don't understand.

Overall, as Peter Lynch says, you're going to do far, far better if you stay where? Stay within those areas of business where you've got your edge. Warren Buffett and Charlie Munger would say you stay within your circle of competence. Phil Town would say you stay around companies that have some sort of meaning to you. Peter Lynch obviously just says you have to know what you own.

So overall, that's kind of Peter Lynch's breakdown on the absolute most important rule of investing. You definitely have to know what you own; you have to take the time to research and understand what you're getting yourself into before you buy it. And it doesn't have to be the most complicated thing in the world.

As he said at the start, you don't have to buy the 50 teraflop this, that, and the other technical computer company if you don't understand computers. If you just worked in construction your whole life, then just look at construction companies because that's where you find your edge. And that's how you will know what you own.

If you know what you own, you make far better investing decisions, and you understand what to do when the price goes up or goes down. You could understand that there's a lull in the construction industry, but over the next three or four years, that's going to pick right back up—no worries.

If the stocks go down, you're like, yes, all right, three years, it'll be fine. You know? On the other hand, if the stock, if a construction stock was going down, you look at that company, and you go, oh, yeah, they've just been breaching a whole lot of different construction-related laws; they're really going down the toilet. Then you can get out of that company and look at something else in the industry.

So it just helps you a lot, and knowing what you own is definitely the first fundamental step in constructing a successful portfolio. But anyway, guys, that is where I will leave this video. Let me know what you think down in the comments section below.

Of course, subscribe to the channel if you're interested in similar videos to this. Leave a like on the video if you did enjoy it or if you found it useful. If you're interested in how I go about my investing, either passive or active investing, you can check out Profitful. Links down the description below, where I've made two completely in-depth courses about those two different investing strategies.

Stock market investing, I'm sorry, introduction to stock analysis is the course that is actually heavily inspired by how Peter Lynch goes about his investing, so if you're interested, you can check that out. Links in the description, but that will do me for today, guys. Thank you very much for watching, and I'll see you all in the next video. [Music]