Monday, January 16, 2012

One up on Wall Street

I recently read "One up on Wall Street" by Peter Lynch (with John Rothchild, 1989). Peter Lynch was a very successful manager for Fidelity's Magellan mutual fund which he directed from 1977 to 1990. According to wikipedia he achieved an average annual return of 29% which is of course terrific. One might expect he could write a worthwhile book on personal investing but in my view this book is not it.

The main problem with this book is its premise (see pages 240-241 in the paperback edition) that with moderate effort following his advice the average person can expect to beat the market averages by 2-5% a year (so if the market averages 10% average annual return you can expect to achieve 12-15%). In my opinion this is totally unrealistic and potentially dangerous advice for the average investor. More realistically an individual investor should expect returns (before expenses) which roughly track the market. Of course if you aren't widely diversified you won't match the market exactly and might in fact achieve excess returns of 2-5% annually for some time. But these will probably just reflect good luck and be no more likely than lagging the market by an equivalent amount.

So if you don't enjoy researching and picking stocks but want to be invested in the market the practical thing to is to invest in an index fund. This takes minimal effort and you should achieve the market return. Index funds are also relatively tax efficient. If you do enjoy picking stocks and have a bit of a taste for gambling then picking out and holding a portfolio of 20 or so stocks is fairly harmless as long as you don't trade too much and spread your picks around. Your expected return won't suffer, you can root for your stocks and you may get lucky and beat the market by a bit. And by managing your own portfolio you can adjust for your personal tax situation. Active mutual fund managers often only think about pretax returns and give up some after tax return by being too willing to take gains. Lynch in fact totally ignores taxes in this book.

A large part of Lynch's book consists of war stories, stock picks of his that did well or poorly. He has explanations and advice based on these examples but to me they just seem to illustrate the adage that it is easier to predict the past than the future. They don't appear to add up to a reliable method for beating the market going forward.

The book also come across as rather dated. References are made to looking up company information in local libraries which subscribe to the Value Line service but I believe this type of information is now widely available on the internet. And 1990 time frame stock picks are mostly of historical interest at this point.

So in summary I would skip this book.

1 comment:

  1. There's a saying that every poker game has a patsy, and if, after 5 minutes, you can't tell who the patsy is, it's you. This is more or less my view of the individual investor, and books written to convince more patsies to sit in for a hand or two at least only add to the impression.

    (I've done pretty well, through nothing but dumb luck.)