The best thing about the MoneyWeek conference was the chance to meet with Red Hot and Penny Sleuth readers. In fact, I got a lot of chances: during coffee breaks, in the queue for the lift, at the buffet…
I had a great chat with one man, Neil.
Neil was attending for the first time and told me he’d resolved to take control of his own finances. He’s just become a father, which has concentrated his mind on planning for the long term. And unfortunately he doesn’t have the backstop that many people of my generation have enjoyed – a final salary pension scheme.
Neil sensibly wants to make sure he knows what he’s doing, rather than relying on the advice of ‘experts’. In this spirit, he asked what book I would recommend to him as a relatively inexperienced investor.
The one book I always go back to
Over the years, I’ve built up quite an extensive investment library, so there were a lot of candidates to choose from. Our modern-day information overload certainly contrasts with the way things were when I started my book collection in the late-’80s.
But for me, there’s one book on my shelf that I’ll keep reading over and over. It’s a great read and is still in print 25 years after it was first published.
It’s called One up on Wall Street by Peter Lynch, and it’s worthwhile reading for every new investor. Lynch was the best-known equity fund manager at the time. And yet his approach to managing his fund was at odds with some of the advice he dispenses to amateur investors in the book.
He also broke one of the most widely accepted rules you should follow in constructing a winning portfolio.
The contrast between his book and business practice is a fantastic example of knowing when to follow the rules, when to break them and demonstrating that there’s no such thing as a ‘one size fits all’ approach to investing.
Peter Lynch’s three investment secrets
The first investment approach from Lynch’s book is diversification. For those of you who don’t know, diversification involves holding a number of different stocks, which significantly reduces risk.
In One up on Wall Street, Lynch talks about diversification using an example of owning just ten stocks. This is probably at the low end of the number I’d recommend, but there’s no need to own many more.
He points out that in a list of ten names, there’s a good chance there will be a couple of stinkers that lose you a fair bit of money. Then there will be five or six that do OK. With a little skill and good fortune, however, you might find one or two that do exceptionally well.
If the best investment turns into a two or three-bagger, doubling or trebling, then it more than pays for the failures. But of course, you don’t know at the start which of the ten stocks you’ve chosen are going to end up as stinkers or stars!
Diversification is regarded by many as the only ‘free lunch’ in investing, but the key for a stock picker is not to overdo it. If you hold too many stocks, then it becomes very difficult to generate a return that’s much different from the index.
So, you might as well own an index tracking fund. Nothing wrong in that, but you do forgo the chance of achieving bumper returns from finding a few great shares.
Studies suggest that a couple of dozen holdings give you all the diversification you need. Hold any more stocks, and you are merely diluting your exposure to the best ones.
But that’s exactly what Lynch did.
Know when to break the rules
Despite his advice about diversification, Lynch held hundreds of stocks in his fund – something that should have condemned him to average performance at best. However, he performed brilliantly for over a decade.
What Lynch was doing was ‘theme investing’, our second investment approach. Theme investing involves spreading your investments across an industry or a theme that looks set to do well.
For instance, when Lynch thought the automotive industry was looking up, he didn’t just buy a big holding in his favourite car maker, Ford for example, and leave it at that. Instead, he bought GM and Chrysler as well.
He also invested in component suppliers, tyre companies and overseas plays such as Toyota. So rather than placing a big bet on Ford, he would have a big bet on the car industry as a whole.
When Lynch stepped down in 1990, the fund was the largest in the world, worth $13bn. This was an exceptional sum at the time and no doubt his thematic approach was a way of dealing with the problems of size and liquidity. It let him express his views on an industry without being trapped with a massive position in an individual share.
Lynch’s book is also notable for advising investors to use their own experience and expertise. ‘Buy what you know’ is our third investment approach. Look around you when you are shopping or travelling. Think of the industry you work in and the companies you deal with or compete against.
If you tune your mind to look at your everyday life from an investment angle, you’ll be surprised at just how well-informed you actually are about many investment opportunities. I’m sure Peter Lynch followed his own advice here – it’s something we should all do.
This ‘buy what you know’ approach sits well with the idea of taking control over our financial futures. But perhaps the greatest lesson from the book is that it demonstrates how different approaches can suit different individuals in different circumstances.
The conference really was a fantastic opportunity in this regard. We had some great speakers, each with a different investment strategy, and it was a great way for investors to find out which approach suited them best.