All investors make mistakes during their lifetimes. In my view, it is impossible to manage your portfolio effectively at all times due to the fluid economic outlook and the infinite number of variables that can affect stock prices.
However, seeking to avoid common errors can be a productive use of your time. It may lead to less risk and a more efficient allocation of capital over the long run.
Peter Lynch has tried to minimize mistakes during his investment career. His avoidance of economic forecasting and willingness to sell underperforming businesses could explain his long-term outperformance of the stock market.
Predicting the economy's future performance
It is tempting to base your investment decisions on forecasts for the economy. For instance, the current uncertain macroeconomic outlook may cause some investors to avoid buying undervalued stocks in favor of less risky investments.
However, it is impossible to predict a stock's future performance over any time period. There are a vast number of variables that can impact stock prices. This makes economic estimates inaccurate much of the time and of little use to value investors.
A better idea could be to focus on buying companies that have the financial and competitive strength to perform well despite possible economic risks. This may lead to them maintaining their market positions in the long run even if there is a prolonged period of weak GDP growth.
As Lynch once said, "The way you lose money in the stock market is to start off with an economic picture. I also spend fifteen minutes a year on where the stock market is going. All these great, heady, thinking deals kill you."
Holding underperforming businesses
It is inevitable that all investors will eventually purchase a company that delivers disappointing financial performance. This may cause its share price to decline to a level that is less than the price paid.
In this scenario, many investors hold on to the stock because they do not want to sell at a loss. However, holding on to underperforming companies can be detrimental to your portfolio's long-term prospects.
A more logical approach may be to sell underperforming businesses and reinvest the capital elsewhere. This may allow you to put your capital to a more productive use in a business that has greater potential to produce capital growth.
Lynch has always sought to sell companies that experience worsening financial performances. As he previously said, "You have to know when you're wrong. Then you sell. Most stocks I buy are a mistake."
Changing your investment strategy
Making minor changes to your investment strategy as you gain experience throughout your lifetime is a common practice that can benefit your portfolio's performance. For instance, you may gain knowledge of how to better analyze a company that helps you to avoid unnecessary risks.
However, making wholesale changes to your investment methodology in response to evolving stock market conditions could be a mistake. For instance, you may be tempted to move away from a value investing strategy and towards a plan that prioritises growth in today's bull market. This may be short-sighted, since the current stock market rally is very unlikely to last forever.
Therefore, sticking with your investment principles could be a more prudent approach. It may allow you to avoid over-optimism in bull markets, as well as excessive pessimism during bear markets when buying opportunities are readily available.
As Lynch once said, "My stock picking method, which involves elements of art and science plus legwork, hasn't changed in twenty years."
Read more here:
- Howard Marks: Contrarian Investing Can Beat the Stock Market
- Charlie Munger: Self-Discipline Is Crucial to Investment Success
- Warren Buffett on What Makes a Successful Value Investor
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