Peter Lynch's Tips to Prepare for a Stock Market Crash

What you learn from history is the market goes down. It goes down a lot. The math is simple.

There’s been 93 years, a century. This is easy to do. The market's had 50 declines of 10% or more. So, 50 declines in 93 years, about once every two years. The market falls 10 percent. We call that a correction. That means that’s a euphemism for losing a lot of money rapidly. We call it a correction.

So, 50 declines in 93 years. About once every two years, the market falls 10%. Of those 50 declines, 15 have been 25% or more. That’s known as a bear market. We’ve had 15 declines in 93 years. So, every six years, the market’s gonna have a 25% decline. That’s all you need to know.

You need to know the market's gonna go down sometime. If you're not ready for that, you shouldn't own stocks. And it's good when it happens. If you like a stock at 14, it goes to six, that's great. You understand the company; you look at the balance sheet, they're doing fine. You're hoping to get to 22 with it. 14 to 22 is terrific. 6 to 22 is exceptional.

So you take advantage of these declines. They're going to happen; no one knows when they're going to happen.

Peter Lynch ran the Magellan Fund at Fidelity for 13 years and turned 18 million into 14 billion at an average annual return of 29.2%. Many people think of Lynch as this stock market big brain genius. But the more you look into him, the more you realize that his success came from a mastery of the long-term investing temperament.

When it comes to investing during a period of extreme volatility, such as a market crash, it's this investing temperament that largely decides whether you succeed or fail.

In this video, I'm going to take you through some clips from this 1994 lecture by Peter Lynch and we'll hear firsthand the mental tips and tricks he used to profit from big market crashes.

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Now, as sad as it is, most investors usually do pretty terribly when they're hit with a market crash. There’s shocking news headlines, you know, fear is everywhere, and people tend to make very silly decisions.

As Peter Lynch will now explain, the first step in profiting from a stock market crash is to just know that a crash will come. You know it's inevitable; your portfolio will be hit and it's only a matter of time. No one can predict it.

People get too carried away, and first of all, they try and predict the stock market. That is a total waste of time. No one can predict the stock market.

But I'm trying to tell you, it’d be very useful to know what the stock market is going to do. It’d be terrific to know that the Dow Jones average a year from now would be X. Then we’re going to have a full-scale recession; our interest rates are going to be 12%. That’s useful stuff. You never know it, though. You just don’t get to learn it.

So I’ve always said if you spend 14 minutes a year in economics, you’ve wasted 12 minutes. And I really believe that. So don’t think you're going to be able to see the crash coming but understand that it will happen. It will catch you out of the blue at some point in your investing career.

So, if you’re going to be a holder of common stock, the first step in profiting from a crash is to be at peace with the idea that you’re going to cop one, and no one can see it coming.

If you are at peace with that idea, then you can start to understand ways to profit from this inevitable event occurring. The key organ in your body in the stock market is your stomach; it’s not the brain.

If you can add eight and eight, get reasonably close to 16, that’s the only level of math you need to know. All you have to know is you're going to see it’s always going to be scary. There’s going to be always something to worry about and you just have to forget all about it, cut it all out, and own good companies.

Own turnarounds, study them, and you’ll do well, and that’s all there is.

When it comes to making money from a market crash, it’s really all about your stomach. You really don’t have to be a genius. You know, the mathematical side of things is actually quite easy, but it’s the temperamental side of investing that’s very tough.

That’s why most people lose money when the market crashes, even though it’s actually raining gold.

At this point, we understand that, you know, these crashes will happen. We won’t see it coming and it’s fear and panic that usually lead us to doing dumb things that cause permanent loss of capital.

So now let’s turn our attention to some of the things we need to do to be able to profit from a market crash. The first step, as Peter Lynch would say, is you need to know what you own.

I made money in Dunkin Donuts; I can understand it. I, uh, 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 laugh; I made 10 or 15 times my money in Dunkin Donuts. Those are the kind of stocks I can understand. You shouldn’t be calling your broker four times a day to get stock quotes; it doesn’t work.

Getting up in the morning to look to see how your stock did yesterday is not useful. You should be looking at the company when you get the quarterly reports.

If you’re at the mall, imagine if you were in the retailing industry or if you were in the restaurant industry. You would have seen Taco Bell; you would have seen McDonald’s; you would’ve seen Toys "R" Us. I mean, you were seeing all these companies do terrifically well.

You've seen Bombay; you're seeing Tandy with Radio Shack, and you've seen Radio Shack roll across the country. Pretty soon, there were, you know, 25 Radio Shacks in every major city, and you said there’s not much room for them to go. But they had a 20-year great run.

That’s what you’re dealing with. You’re not dealing with the minutia of today; you’re dealing with what this company is doing two years, three years, four years, five years from now.

So, Peter Lynch touches on two key points that honestly will get you through any market crash very, very well. The first point is to understand what you're holding in your portfolio.

You know if you really do understand what you've bought, your fear and anxiety will be vastly reduced when the stock is plummeting because you know you're holding a great business. You know that business is rock solid; it has no debt, for example, has great profit margins, it has a huge competitive advantage, and you went in and you did the calculations, and you worked out that you bought it well below its intrinsic value.

You know if you know that, when the stock craters, you’ll actually start getting excited because you know that you're actually buying one dollar for 50 cents.

But if you haven't done the work, then when that stock plummets because of, you know, ABC reasons, you won’t know where that company will be in a year's time.

You know it’s like going scuba diving. You always check your equipment, you check the ocean conditions, you make sure you go out with a buddy; you don’t just grab your regulator and just wing it at 10 PM at night by yourself and just hope for the best.

Overall, the more checks you do with your companies, the better off you’ll be at making smart decisions when the sky is falling.

Then secondly, Lynch also touches on the idea of maintaining a long-term investing outlook. You know, if the stock market crashes and you're expecting to make, you know, 10% this month, maybe to help cover your rent payments? Good luck! You’ll definitely lose money, but if your goal is to say, come out ahead in ten years' time, then all of a sudden, stock market crashes are not scary at all.

They’re just like black Friday sales but in the stock market. You find the right businesses, buy them up when the stock market is depressed, and then you wait. You just wait. That’s all you have to do; you wait for the market to eventually correct itself over the next year, two years, three years, and then you’ve made money.

Look, even in the GFC, it only took five and a half years to get back to where you were at the previous top, and if you held on for ten years, well, you’ve made a lot of money.

So don’t think you have to get, you know, you have to understand it and say they’re doing well. As long as they keep doing well, my best stocks have been my fifth, sixth, seventh year I own them, not my fifth, sixth, seventh day. So you have to understand that and, uh, stay with it.

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, you could’ve 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, uh, over 30 times your money. You could wait three years after Microsoft went public and made ten times your money.

So find the great companies and stick with them. Then if the market does crash, you know, run over your valuation and you’ll probably find you have an amazing long-term opportunity to buy the business very cheap.

You know, as Buffett says, we buy one-dollar bills for 50 cents. That’s our goal.

The other thing Peter touches on in that clip is how you only need a few killer stocks in your lifetime. You know, normally it’s extremely hard to find these kinds of opportunities, but the crazy thing about a market crash is that these infrequent buying opportunities actually start popping up everywhere.

You know, in big market crashes like the GFC, basically your entire watch list will become so cheap that all the stocks represent big multi-bagger opportunities.

So knowing that you only need a few big stocks in your lifetime and these opportunities normally come very infrequently, hopefully that changes your mindset in the depths of a big market crash.

Turn that feeling of fear into a feeling of opportunity. You know, this is rare and I’m gonna grab it with both hands.

Then lastly, I also just wanted to play one final clip from Peter about a very desirable characteristic of a company, particularly during a recession or a market crash.

There’s a lot of times people buy on the basis the stock has gone down this much. You know, how much further can it go down? I did the same thing in my, uh, I think my first or second year at Fidelity. Kaiser Industries had gone from 26 this year to 16. I said, "How much lower can it go? It's 16."

So I think we bought one of the biggest blocks ever in the New York on the American stock exchange of Kaiser Industries at 14. I said, “You know, it's gone from 26 to 16; how much lower can it go?”

Well, at 10, I called my mother and said, "Mom, you’re gonna love this Kaiser Industries. I mean, how much lower can it go? It's gone from 26 to 10."

Well, it went to 6. It went to 5. It went to 4. It went to 3, and at 3, I figured out, you know, there’s something very wrong here because Kaiser Industries owns 40% of Kaiser Steel, they own 40% of Kaiser Aluminum, they own 32% of Kaiser Cement, they own Kaiser Broadcast, and they own Kaiser Santa Gravel, Kaiser Engineers; they own Jeep.

They own business after business, and they had no debt. Now I learned this very early; this might be a breakthrough for so many people. It’s very hard to go bankrupt if you don’t have any debt; it’s tricky. Some people approach that as a real achievement, but they had no debt, and the whole company at 3 was selling at about 75 million.

At that point, it was equal to buying one Boeing 747. I said, "There’s something wrong with this company selling for 75 million." I was a little premature at 16, but I said, "Everything's fine, and eventually this will work out."

What they did is they gave away all their shares to their shareholders. They passed out shares in Kaiser and they passed out shares in Kaiser Aluminum; they passed out their public shares in Kaiser Steel. They sold all the other businesses, and you get about fifty dollars a share.

But if you didn’t understand the company, if you’re just buying on the fact the stock had gone from 26 to 16 and then it got to 10, what would you do when it went to 9? What would you do when it went to 8? What would you do when it went to 7?

This is the problem that people have. They sell stocks because they didn’t know why they bought it. Then it went down, and they don’t know what to do. Now do you flip a coin? Do you walk around the block? You know, what do you do?

He’s absolutely right. Most people don’t know what to do when the stock goes down because they don’t know enough about the company.

What was interesting about his story about Kaiser Industries is he knew the business was fine because it had no debt. If the cash flows stay decent enough to cover the expenses, if the business has no debt, then it’s practically impossible for that company to go bust.

So another tip in recessions, scary times, market crashes is just to make sure that your companies have debt levels under control. You know, for example, Facebook has no debt; Google has, I think, 14 billion dollars in debt, but it has 142 billion dollars worth of cash or short-term marketable securities. They’re just not going bankrupt.

And if they aren’t going bankrupt, if nothing can force them into bankruptcy, then it’s only a matter of time before the market crash or the storm is over and things just go back to the way they were.

So there’s another reassuring factor, you know, in the depths of a recession if your company has no debt, you have that added layer of security about the future of the business.

But anyway, guys, that would just about do for today. They are Peter Lynch's tips as to not only surviving but thriving from market crashes.

I really like listening to Peter talk because he’s just so damn rational. He just knows exactly what to say. But hopefully, that gives you a little bit of insight into kind of the mindset and the tips and tricks of how you can actually end up profiting quite substantially from stock market crashes.

They are, you know, if maybe you haven’t been through a big one before, they are quite scary, particularly for new investors. But really, when you take the time to understand this long-term investing temperament, they represent the best opportunities you will ever get in the stock market. Long-term stock market crashes are your friend.

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