Peter Lynch: Everything You Need to Know About Investing in Less than 13 Minutes

If you want to build wealth and get rich from the stock market, you need to be studying Peter Lynch. The beauty of his investment approach is that it is so darn simple. If you follow his teachings, you don't have to have an MBA from Harvard or be a Wall Street data scientist from MIT. Thankfully for us, Peter Lynch shared all of his investing secrets in the books he wrote and the countless interviews he gave.

I went through all of his materials and boiled it down to the four absolute must-know lessons that you need to invest successfully. It would mean the world to me if you could give this video a thumbs up and subscribe to the channel because a ton of work goes into putting these videos together. As Lynch says, anyone can be a successful investor, so make sure to stick around to the end of this video because you're going to see firsthand what he means.

Before we jump into the four investing lessons from Peter Lynch, there is something you have to understand. Let's call this lesson zero: there is no such thing as a natural-born investor. There's no family gene that makes someone a great ambassador. Almost all of Lynch's relatives distrusted the stock market, partly due to them having grown up during the Great Depression. Additionally, you don't need a high IQ to follow Peter Lynch's strategy. As Lynch says, if you can add two and two together and get roughly close to four, you have the intelligence needed to make money from the stock market.

Peter Lynch himself had an atypical background for someone working on Wall Street. In college, he studied history, psychology, and philosophy, not business, finance, or mathematics—areas usually considered an entry requirement to get a high-profile job on Wall Street. Lynch also attended Boston College. While Boston College is a great school, it's not Harvard, Yale, or Princeton. In retrospect, Lynch feels that studying history and philosophy prepared him to be a better stock investor because investing is an art, not a science.

The point I'm getting at here is that great investors can come from any walk of life and background. Peter Lynch proves that. So now that you understand you have what it takes to be an investor, let's get into the list.

Lesson number one: know your edge. The average individual investor has no idea the knowledge advantage they have over the pros. Here's what I mean: I work for a large investment fund based out of New York City. The sector of the stock market I'm responsible for covering for my investment team consists literally of thousands of stocks across the globe. Even though I work about 12 hours a day, there's only so much time during a working day. It is literally impossible for me to know every single detail about the thousands of potential stocks out there.

What happens is that there are roughly 10 to 15 stocks that I know incredibly well and then about 50 to 60 more that I follow relatively closely. This dynamic creates opportunity for the individual investor. Individual investors can focus on the stocks Wall Street are ignoring. Often, these companies tend to be smaller in size, as they're usually not big enough to get Wall Street's attention. It's incredibly easy to find a list of companies that could be potentially flying under Wall Street's radar.

While Lynch was investing in the 70s and 80s, the internet wasn't readily accessible. Here in 2023, you have to use your resources to your advantage to find a list of smaller companies. All you have to do is go to a stock screen like this one here. With this particular one, go to the market cap option and select small (300 million to 2 billion). Hit enter, and you are left with a list of around 1,700 stocks that fit this criteria just in the United States and Canada. I guarantee there are plenty of great companies on this list that Wall Street investors have no idea about.

Moving on to lesson number two: know what stocks to avoid. Arguably even more important than knowing which stocks to buy is to know which stocks not to buy. Legendary investor Charlie Munger has a saying: "I want to know where I'm going to pass away so I never go there." What he's getting at when he says this is that a large part of being successful in any endeavor isn't necessarily doing everything incredibly well. Instead, it's avoiding doing stupid things. This is especially true for investing.

Meet our friend here, John. John has a goal of building wealth. He works hard, lives below his means, and sticks to a budget. His diligence has paid off; John was able to save ten thousand dollars that he can invest in the stock market. John's on YouTube once a night and comes across a fast-talking finance YouTuber promoting a certain stock to his viewers. This YouTuber is talking about how the stock is the next big thing and a can't-miss opportunity.

This YouTube video here is the modern-day equivalent of the stock tip from a stranger that Peter Lynch warns about. Unfortunately for John, he doesn't watch investor-centered videos, so he doesn't know any better. Well, as a quick aside, make sure to subscribe to the channel because you don't want to end up like our guy John here. Because John didn't know any better, he put his entire ten thousand dollar savings into this one stock. The stock went on to sink like a heavy rock thrown into water; it lost 90 percent of its value before John gave in and sold it.

Since the stock decreased by 90 percent, John needs to find another stock that will increase by 90 percent to break even—right? Wrong! Sadly for John, that's not how numbers work. John's ten thousand dollar investment fell to one thousand dollars with a 90 percent decrease. So in order for him to get back to ten thousand dollars, he needs to find a stock that will increase by a factor of 10—not an easy task by any means. This example demonstrates just how important it is to make sure you know which stocks to avoid. As Warren Buffett's famous saying goes, "There are two rules to investing: rule number one, never lose money; rule number two, never forget rule number one."

Lynch calls out three types of stocks to avoid. The first is "the next big thing." If a stock is being heralded as the next Amazon or the next insert big company name here, Lynch recommends avoiding it like the plague. These types of stocks trade at high valuations, meaning any bump in the road for the company is going to cost investors a ton of money.

The second type of stock Lynch recommends avoiding is companies that are doing diversification. These are companies that are entering unattractive new markets for no good reason. Oftentimes, companies do this by paying a premium to buy another company. The winners in that situation are the shareholders of the company that was acquired. The third category of stocks to avoid are what Lynch refers to as "dependents"—user companies that rely on a small number of clients for a large part of their business. If just one or two of those big customers leaves, it can be big trouble for the stock.

Moving on to lesson number three: don't sell your winners too early. Many investors have a tendency to sell the stocks in their portfolio that have increased the most while simultaneously buying more shares of the companies that have seen their stock prices decline. Lynch refers to this as "watering the weeds and cutting the flowers." I'll let you in on an embarrassing story for my own investment portfolio.

I have been following the likes of Peter Lynch, Warren Buffett, and Charlie Munger for years. As a result, I knew that pullbacks in stocks could be a great buying opportunity. In late 2018, Apple stock had fallen by over 30 percent on concerns about slowing iPhone demand. Apple's management had decided to stop disclosing the number of iPhone shipments the company made in any given quarter, and this threw Wall Street and professional investors into a tailspin. Investors sold off the stock in droves.

Me, being more long-term focused, was still a big believer in the company, and I found the stock's valuation to be attractive. I made Apple the second largest position in my personal stock portfolio. I bought shares in the company at an average price of around $37 on a split-adjusted basis. In early 2020, I started getting my finances in order to buy a house. As a result, I had to sell a portion of my stock portfolio to get cash for the down payment. To use Lynch's analogy, I made the mistake of cutting my flowers.

I ended up selling my entire Apple position because it had performed so well. I cut my flowers when I should have been cutting my weeds. I sold out of Apple at around $75, only to watch the stock continue to rise all the way to the roughly $180 per share it trades at currently. Behavioral finance is an area that really interests me ever since I first listened to Charlie Munger's famous lecture "24 Standard Causes of Human Misjudgment." Behavioral finance attempts to explain the psychological reasons why people do certain things with money; these psychological biases prevent us from making optimal decisions.

There is one of these biases that really stands out when trying to understand why people sell winners too early: it is called loss aversion. This is where humans dislike losses more than they like the equivalent gain. Think about this example: imagine your employer gave you an unexpected bonus of one thousand dollars. Would you be excited? Well, of course you would! You'd probably walk around with a little extra pep in your step the rest of the day.

But think about the alternative scenario: what if you had been promised a one-thousand-dollar year-end bonus all year long? You would already have spent that money in your head; that money was already yours, as far as you were concerned. You go to open your year-on paycheck expecting to see that promised bonus, and it's not there. Under the bonus line item on your pay stub is a big fat zero. How do you think you would feel? You would be irate and probably want to find another job. You would likely be mad at your employer for weeks, if not months.

Notice how with this hypothetical example, even though the dollar amount was the same, the likely emotional response to losing the money was way stronger than gaining it. This phenomenon exists with investing. In hindsight, it's clear how I fell victim to loss aversion when I sold Apple. I had seen the value of my shares increase significantly, more than doubling from the price I paid. Subconsciously, I wanted to lock in this gain by selling the shares before it could be taken away by the whims of the stock market. If you understand this concept, you are ahead of nearly every other investor out there, Wall Street professionals included.

Moving on to lesson number four from Peter Lynch: focus on the micro, not the macro. Here's what I mean when I say focus on the micro. Many investors make the mistake of worrying about what's going on in the economy. Instead, they should be focusing on what's happening within a specific company and the industry in which it operates. Put another way: don't focus on macroeconomics; focus on microeconomics. Microeconomics is the study of individuals and business decisions, while macroeconomics looks at the decisions of countries and governments.

Macroeconomics focuses on whether the economy will be in a recession this year; microeconomics focuses on whether it makes sense to invest in the auto industry, for example. Using the auto industry as an example, microeconomics focuses on things like what the future profitability will be for the industry, what companies will be the winners, and how electric vehicles will change the dynamics within the industry. Many times, with microeconomics, you can make a reasonable guess that frequently turns out to be correct. However, macroeconomics is a complete guessing game. Even the most highly respected economists are nearly always wrong in their predictions.

To use the words of Warren Buffett, "Any company that has an economist on payroll has at least one employee too many." If you rely on macroeconomic predictions when investing, there are actually two correct predictions you have to make. The first is what's going to happen in the economy. Given the track record of economists, the odds of someone doing this successfully is low. However, there is also a second thing you have to get correct that isn't frequently talked about. Not only do you have to correctly predict what's going to happen in the economy, you also have to accurately predict how the stock market is going to react.

Let me explain what I mean. Let's travel back in time to early 2020, and let's say by some miracle you were able to accurately predict what’s going to happen in the economy. You correctly predicted that the economy was about to enter a difficult time, that GDP would contract and the unemployment rate would skyrocket from 3.5 percent to nearly 15 percent virtually overnight. You got that part of the equation right. However, in order to actually make money from that prediction, you would have to accurately predict how the stock market would react.

If you sold stocks in early 2020 because you knew the economy was going to suffer, that decision would have cost you a lot of money. Despite 2020 being one of the most difficult years in the history of the US, the S&P 500 was up over 18 percent that year. This is why it is so difficult to invest based on economic predictions. Even if you correctly predict the economy, by no means are you guaranteed to make money on that correct call.

Compare that to focusing on the microeconomics of a particular business in the industry it operates in. Let's say you're a huge car guy; you know everything there is to know about cars, and you spend all of your free time studying the industry's trends and upcoming product launches. You probably have an understanding of what companies are putting up better products, and which companies are the best. You have a deep understanding of the microeconomics of this particular industry. In this industry, your knowledge base is so deep that you have an edge over the professional investors who don't have an understanding of what's going on there.

There are plenty of industries out there where you, as an individual investor, could have a deeper understanding than the professionals. It could be restaurants, fashion, video games, computers, building materials—the list goes on and on. The point is that you can have an edge over the professionals when you focus on the microeconomics of an industry you're familiar with, as opposed to trying to profit off of macroeconomic predictions.

So there we have it. Make sure to subscribe to the channel because it's my goal to make you a better investor by studying the world's greatest investors. Talk to you again soon.