Many people want to be investors, but not all investors are qualified. In fact, common mistakes are often repeated, again and again, hurting investors results and profits. In this article, Peter Lynch warns you about all dangerous ideas you ought not to follow blindly.
Who’s Peter Lynch again?
Peter Lynch is likely one of the most famous investors of all time. For those of you who may not know him, he was fund manager at Fidelity Investments, head of a fund called Magellan. In his 13 years as manager, he managed to grow the fund from $18 million to $14 billion, making it the largest mutual fund in the world at the time.
#1: “It can’t go any lower.”
Sometimes it will not, sometimes it will. Very often the price of a stock has fallen for good reason. There are no imaginary lines regarding losses, any stock can eventually reach the price of zero and delist from the exchange. The stock price is determined by many factors such as the company’s fundamentals, its promises of cashflow and its perception in the mind of investors. Believe it or not, even a stock that lost 80% of its value can lose even more of it, all the way down to zero.
#2: “How could it possible go any higher?”
Many investors will say that they are simply too late after seeing important gains on a stock. A company stock that saw gains recently can perfectly see additional gains following it, especially if this price increase was justified by strong fundamentals. Peter Lynch warns investors that do not dare investing for fear of having missed the moment. If the company fares well and gives strong returns, there is not reason that its stock should not continue gaining in the long term.
#3: “Eventually they always come back.”
Some stocks will come back to their old price levels, but some simply will not. Although it is true that the S&P 500 is rising over time, it does not mean that this is the case for every single company. Investors that enter a losing position should have a strategy about cutting losses. It is alright to lose money on an investment but hoping for it to come back is not enough, sometimes, one needs to take losses to make sure they do not become too important.
#4: “How much can I lose?”
Well, eventually everything. Let us say your friend buys $10,000 worth of shares when the stock price is at $50. Now the stock is at $3, and you buy $10,000 worth of shares. If the stock goes to zero who lost the most? Many people cannot answer this question but believing that there is nothing to lose can be a fatal mistake.
#5: “It is the darkest before dawn.”
This saying can also be a great opportunity to lose money. Lynch uses the example of oil drillers in the U.S. In 1982, there were 11,000 oil drillers spread around the country, a number that went down to 6,083 the same year. Many companies were involved in the business: drilling companies, logistics companies, bid companies, etc. Many people suggested to buy these businesses when they were cheap. But it turns out that oil drillers went down to 1,000 only a couple of years later. Implying that things “cannot get worse” is a great way to blind oneself. Remember, if business is terrible, it can sometimes simply get even more terrible.
#6: “I’ll sell after the rebound.”
You have probably said or heard this: “I’ll sell when it rebounds to $10.” Imagine you buy a stock at $10 and it drops to $7. If you think that it will go back to $10, the sound move would be to buy, instead of holding your already losing investment and hope to break even – indeed, this will mean a 42% return, if your price expectation comes true. And if you do not believe it will happen, why not sell and cut losses before the stock drops further?
#7: “I don’t have to worry; I own conservative stocks.”
Although conservative stocks do tend to show more resilience and stable prices, it does not mean that they are out of danger. During the 2008 financial crisis, many quality banks in the US and the UK, that were founded over 100 years ago in some cases, have seen their stock price fall to zero. Long Island Lighting, a U.S. utility company founded in 1911, deemed essential and conservative, still managed to go defunct in 1998, after almost 90 years of existence. Companies are by and large dynamic in the long-term, conservative is an over-used adjective.
#8: “Look at all the money I’ve lost by not buying.”
“I didn’t buy Amazon, I didn’t buy Apple…” People spend too much time worrying about missing great opportunities like Microsoft or Alphabet, focusing on what they did not do. But the fact remains that you cannot lose money in a stock you do not own. The only way to lose money trading stocks is to buy a stock and sell it at a lower price, that is it. You did not lose money by not buying a stock that is up 3% today. One thing to beware of is not to get hit by FOMO (fear of missing out) and try to find the “next something”. Copycats tend not to do as well as original thinkers.
#9: “The stock is going up: I must be right.”
Sometimes, people buy a stock at $15. When it goes up to $20, they feel validated in their investment choice and buy a thousand more shares. And then cry when the stock falls back to $10. One should remember that the average movement of a stock during a year on the New York Stock Exchange this last century between its high and low has been 50%. This means that a stock will open the year at $20, go up to $27, drop down to $18 and finish the year at $21. Stocks go up and down all the time, and a gain is in no way a clear indication to buy.
#10 “Avoid long shots.”
Peter Lynch calls these stocks “whisper stocks.” These are stocks that give you all the promises in the world in how they will enhance the life of millions, change the way the world runs, revolutionize entire industries. The issue is, they have no sales yet, but you must trust them, because when they will, it will be mesmerizing. Lynch took 30 of these shots but never broke even on any of them. He even calls them “no shots”. It is very easy to regret not investing in Amazon, but in reality, the chance of landing an investment on such a successful company is rather small and offers little to no return on average. Always look for sales, market opportunity and business fundamentals instead of shiny promises.