Workplace Bias
If you follow Peter Lynch’s advice to invest in the industry you work in, you’ll most likely end up just investing in the company you work for. Statistically, people are more likely to be optimistic about their employer’s prospects than the prospects of their employer’s competition.
According to a New York Times article (2), employees consistently overweight their 401K investments in their own company’s stock. The article points out the folly in this:
“Given the employment risk you already face by getting your income from a single source, do you really want to bet even part of your retirement money on that company? How much do you really know about its prospects, its competitors and forces way beyond your control? And how much are you willfully blind to?”
In other words, you already rely on your employer for a paycheck, why have your investments rely on them too? Who’s to say your company isn’t the next Enron?
Favoritism
Similarly, it’s a mistake to invest in a stock just because you like the company’s products. This is an all-too-common practice by individual investors. In fact, so many people buy stocks based on their favorite products that Peter Lynch recently had to clarify his advice.
In a late-2015 Wall Street Journal article, Lynch stated, “I’ve never said, ‘If you go to a mall, see a Starbucks and say it’s good coffee, you should call Fidelity brokerage and buy the stock.’” Instead, he implies that liking a company’s product is considered “specialized knowledge.”
The article explains his thinking this way: “Use your specialized knowledge to home in on stocks you can analyze, study them and then decide if they’re worth owning.”
Using your favorite products as a starting point for stock selection is never a good idea, no matter how much further analysis is performed. It’s too easy to get distracted and let the excitement of a trendy product interfere with objective fundamental analysis.
Limited Options
When you only invest in companies you’re familiar with – whether it’s the place you work or a product you love – your options are extremely limited. Warren Buffett admits this: “And if that circle only has 30 companies in it out of 1000s on the big board, as long as you know which 30 they are, you will be OK.”
Is it really OK to limit yourself to 30 investment opportunities? The odds of finding one – let alone multiple – undervalued stock(s) in your specific circle of competence is minuscule.
It’s hard enough to find high quality value stocks in the market. It’s nearly impossible to find good investments when you only invest in what you know.
Portfolio Formation
If individual investors shouldn’t listen to Warren Buffett or Peter Lynch’s advice, whose advice should they take?
For any true value investor, the answer is obvious: Benjamin Graham.
In 1976 – after more than 60 years on Wall Street – Benjamin Graham gave a Q&A interview with Financial Analysts Journal. When asked which investment approach he recommended for individual investors, his answer was profoundly simple:
“Essentially, a highly simplified one that applies a single criteria or perhaps two criteria to the price to assure that full value is present and that relies for its results on the performance of the portfolio as a whole–i.e., on the group results–rather than on the expectations for individual issues.”
The Father of Value Investing believed that individual investors should use a simple stock selection strategy to build their portfolios. He favored buying a group of undervalued stocks based on only one or two criteria.
Rather than trying to be the next Warren Buffett or Peter Lynch, do what’s practical and intuitive by following Graham’s advice.
Note: Mitchell Mauer is the Founder of TheStockMarketBlueprint.com. The Stock Market Blueprint is a site that finds value stocks for investors building long-term wealth. The site’s investment philosophy is anchored in principles established by Benjamin Graham and his most reputable followers over the last 100 years.
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