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I’m going to let you in on a secret during this video. Everyone is getting it completely wrong when it comes to investing. Conventional investing wisdom states that the average person doesn’t stand a chance against the pros on wall street. However, believe it or not, the individual investor has a massive advantage over professional investors. But please don’t take my word from it. This is coming from legendary investor Peter Lynch. Make sure to stick around to the end of this video because we are going to cover the 4 most important pieces of advice from Lynch on how he recommends people invest small sums of money. Let’s get into it.
According to Peter Lynch, the cardinal rule of investing is “know what you own and why you own it. This means that if you own a stock, you should have a deep understanding of the company, its products, and what separates the business from its competition. Additionally, you should be able to explain to a kid why you own the stock. I remember the first time I ever heard this advice from Lynch. I was a college student and had just finished his must read book, One Up on Wall Street. In this book, Peter Lynch talked about how even professional investors often buy stocks without really understanding the business or being able to explain why it makes sense to own it. At first, I thought there was absolutely no way this could be true. Professional investors are some of the most intelligent, well educated people on the planet. I believed professional investors could never do something so foolish. Well, then I joined the industry myself as one of those professional investors and saw for myself just how true Lynch’s words were.
For background, professional investors have their investment performance evaluated relative to an index, often the S&P 500. The S&P 500 index consists of the roughly 500 largest companies in the US economy. The index is weighted based on the market cap of each company, with the larger market cap companies accounting for a larger percentage of the index. That means that the larger a company is, the more its stock performance drives returns for the entire index. Let’s use Nvidia as an example. Nvidia has a current market cap of 1 trillion dollars and accounts for roughly 3% of the entire S&P 500 index. While 3% may not sound like a lot, one company making up 3% of the value of an index with 500 companies is truly massive.
Nvida stock has been on a tear recently, up 200% over the past year as of the making of this video. Nvidia is a technology company known for designing and manufacturing graphics processing units. The average portfolio manager on wall street is likely in their 40s or 50s with a finance background. Put another way, they aren’t geniuses when it comes to cutting edge technology
If a professional fund manager followed Peter Lynch’s advice of only investing in companies they understand, there is a good chance they wouldn’t have owned Nvidia stock. Investors in this professional investors fund would likely be upset at him for missing out on Nvidia. Professional investors are human. They have a mortgage payment every month and bills to pay. They want to keep their job and to do that they have to keep their investors happy. This often results in professional investors owning stocks they don’t understand and owning them for no reason other than to make themselves look better to current and potential investors in their fund.
Thankfully, individual investors don’t have this problem. The only investor they have to answer to is themselves. Simply following Lynch’s rule of “know what you own and why you own it” will put you ahead of most wall street investors.