Learn to Earn by Peter Lynch #2

Key Points Continued

Invest for the Long Term

Starting early and being patient is all you need to do to make a good return in the market. A small amount of money invested early is worth more in the long run than a larger amount invested later. People who need to pull their money out over a short period such as 1 year, 2 years or 5 years shouldn’t bother with stocks as there is simply no telling what the stock prices will do from 1 year to the next. This is something that can be seen by the current pandemic. But with that being said, if you had consistently invested throughout this period and set your goal over a longer-term such as 20 or 45 years, you would’ve felt the crash but you also would’ve captured stocks at 30% — 70% discounts and gained all of the market recoveries with gains of over 100%.

The reason to start early is compound interest. Check out the illustration below to understand it’s the importance and the effect it has on your retirement.

You can be a genius at analyzing which companies to buy, but unless you have the patience and the courage to hold on to the shares, you’re an odds-on favorite to become a mediocre investor. It’s not always brainpower that separates good investors from bad; often, it’s discipline.

How to think about investing in Index Funds/ETFs

At this point, we come to two conclusions. First, you should invest in stocks and second, you should hold on to these stocks as long as the companies behind them continue to deliver great fundamentals (which means keeping track of their earnings report every 3 months). The next thing you have to decide is whether to pick your own stocks or let somebody else do it (The likes of ARK Invest) or buy a broad-based market fund (The likes of Vanguard).

An index fund or ETF has the advantage of having a manager or the market do all work of figuring out(What to buy?, When to buy?, When to sell?) and allocating position sizes (How much to buy or sell?). This can be seen as less risky than owning only one stock due to diversification if you’re a novice investor.

Now, you could stay up day and night studying how to choose the right fund for you and your risk tolerance, and you wouldn’t get through half the information that’s out there.

Here are a few pieces of advice on thinning the possible funds/ETFs:

1. If you’re a long-term investor, ignore all the bond funds and hybrid funds (those that invest in a mixture of stocks and bonds) and go for the pure stock funds/ETFs.
2. Pick an index to follow the market returns if you want to avoid headaches and looking at quarterlies or the daily ETF holdings.
3. Follow a star fund manager with a long term track record of beating the market rather than focusing on a particular ETF or it’s holdings. Understanding the ETF shows the past returns and understanding the fund manager shows the future returns.
4. Over time, it’s been more profitable to invest in small companies than in large companies. So focus on a broad-based small-cap ETF for the long term.
5. Only change ETFs or index funds if the underlying fundamentals change. Such as a change in the fund manager or management/other fee increases.

Picking your own stocks

If you have the time and the inclination, you can embark on a thrilling lifetime adventure: picking your own stocks. But two problems confront you right away: How do I figure out which stocks to pick? where do I get the money to buy them? Since it’s dangerous to put money into stocks before you figure out how to pick them, you should put yourself through some practice drills before you risk your cash.

Much like fantasy football, where you pick an imaginary team from the major league rosters to see how your team does and how they measure up against the real teams, or other fantasy teams? You can train for stocks with a fantasy portfolio using a stock simulator.

Take an imaginary amount of money like $100,00 and use it split it 5 ways to buy shares of $20,000 worth in your favorite companies such as Amazon, Apple, Nvidia, Microsoft & Mastercard. Choose a starting date like Jan 3, 2011, and your fantasy lineup looks like this:

Once you’ve chosen your stocks and written down the prices, you can track your gains and losses just as you would if you’d put in hard cash.

Playing this stock market game can be fun as well as educational, as long as you’re able to visualize yourself during the ups and the downs, whilst understanding the basics of investing and analyzing company fundamentals.

The highest form of stock picking comes from doing your own research. You choose the stock because you like the company, and you like the company because you’ve studied it inside and out.

The more you learn about investing in companies, the less you have to rely on other people’s opinions, and the better you can evaluate other people’s tips. You can decide for yourself what stocks to buy and when to buy them.

There’s a lot to know about a company before you invest in them. Here are a few things to look for:

1. You have to know if the company is spending it’s cash wisely (High ROI = Return on Investment).
2. You have to know how much it owes to the banks (Low Debt to Equity).
3. You have to know if the sales are growing (Growth in Revenue).
4. You have to know how net profits it has earned in the past years (Growing Net Income).
5. You have to know it’s Total Addressable Market (TAM), the current competitors in its space and whether they have a competitive advantage.
6. You have to know if the stock is selling at a fair price ( Price to Earnings / Price to Sales, but it really depends on your risk tolerance and your belief in the company to grow it’s revenue/earnings).

Investing is not an exact science, and no matter how hard you study the numbers and how much you learn about a company’s past performance, you can never be sure about its future performance.

Your job as an investor is to make educated guesses about which stocks to buy and not pay too much for them. Then, keep watching for good news or bad news coming out of the companies you own. You can use your knowledge to keep the risks to a minimum.

In the next post, we’ll look at Owing Stocks for Real, The Perks of Ownership, The Growth Factory and How to Catch a Twelve-Bagger!