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Some Tough Love from Two Legendary Investors

Steve is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

As retail investors in an increasingly-connected world, it's easy to feel overwhelmed by the thousands of conflicting opinions readily available to us in the media.  Investing great Peter Lynch summed this up nicely when he wrote "You can find good reasons to scuttle your equities in every morning paper and on every broadcast of the nightly news."  

Legendary investor Benjamin Graham put it another way, writing "The stock investor is neither right nor wrong because others agreed or disagreed with him; he is right because his facts and analysis are right."

It's safe to say Peter Lynch knows his stuff; the famed author of "One Up On Wall Street" earned an annualized 29% gain as the manager of Fidelity's Magellan Fund from 1977 to 1990, beating the market in 11 of those 13 years.

Compared to Lynch, Graham's words often sound a little old-fashioned; after all, he passed away at the age of 82 the year before Lynch took the helm at the Magellan Fund.  He also wrote the first edition of "Security Analysis" in 1934, and followed up with "The Intelligent Investor" in 1949.  Still, as Warren Buffett's mentor and widely known as the "father of value investing," Graham's seemingly-prophetic advice repeatedly stands the test of time.

On one hand, much of their collective wisdom is encouraging, like Graham's assertion anyone who "made it through fifth grade math" is capable of following the stock market.  On the other, many of their thoughts revolve around eloquently rebuking investors for being lazy, impatient, obsessive, and emotional. (Ouch!)  

Let's take a deeper look, then, at some of the most difficult-to-follow advice from two of the world's greatest investors. 

Graham on beginners: "We urge the beginner in security buying not to waste his efforts and his money in trying to beat the market. Let him study security values and initially test out his judgment on price versus value with the smallest possible sums."

Beating the market is harder than it sounds.  If you're new to stocks, Graham says, you should fight the urge to dive in head first.  Rather than betting your entire life savings on an unproven stock-picking ability, get your feet wet by starting with a small amount of money.  Even better, consider starting a new CAPS profile to track your picks and hone your skills without putting any money at risk.

Lynch on unrealistic expectations: "You get recessions, you have stock market declines. If you don't understand that's going to happen, then you're not ready, you won't do well in the markets."

Since the Great Depression, the United States has experienced thirteen painful recessions.  The question is of when, not if, the next recession will occur.  Knowing in advance your stocks will eventually revert to the mean will help ensure you're well-prepared to take advantage of Mr. Market's future irrational moves.  

As Lynch later elaborated, "It's a great feeling to be caught with your pants up."

Graham on emotional investing: "Individuals who cannot master their emotions are ill-suited to profit from the investment process."

Most investors can agree this one's easier said than done.  I'd love to say I learned a lot about controlling my emotions from watching the markets plummet in 2009.  Still, it took everything in me to avoid panicking as my shares of Under Armour (NYSE: UA) plummeted 35% in a little less than a month after posting disappointing Q2 earnings last year.  After I held it together and decided the company was still worth holding, shares of UA quickly rebounded as the market came to its senses.  Even today, investors are left with another opportunity to buy UA as it trades more than 16% below its 52-week-highs following another "disappointing" quarter.  

Lynch on doing your homework: "Unfortunately, buying stocks on ignorance is still a popular American pastime."

Keep in mind this is coming from the man famous for his "buy what you know" mantra.  When Lynch suggested buying what we know, however, he wasn't recommending blindly purchasing shares of companies whose products we encounter often.  Instead, he was referring to the need for investors to have an intimate knowledge of the businesses behind the stocks they own.  

As an example, you may be familiar with Citigroup (NYSE: C) if you write them a monthly check for your mortgage, but can you comprehend the scope and risk associated with its equity derivatives business?  Yeah, me neither.  In fact, Citigroup's incredible complexity is one primary reason I refuse to buy its shares.  Based on Lynch's advice, you should have similar reservations unless you're confident in your ability to fully analyze this banking behemoth.

Graham on obsession: "The investor need not watch his companies' performance like a hawk; but he should give it a good, hard look from time to time."

This statement makes even more sense now than when Graham wrote it in the 1940's.  Given today's technology and with real-time quotes continuously at our fingertips, how often do you check your portfolio?  Once every week?  Once each day? Several times per day?  Whatever the number, it might be wise to cut it back a bit.  If you can, I'm willing to bet you'll sleep better when you're not trying to over-analyze the short-term movements of your stocks.

That's not to say we should ignore significant events.  When shares of MAKO Surgical (NASDAQ: MAKO) were absolutely crushed following two awful quarterly earnings reports, I managed to follow Graham's advice and took a good, hard look at MAKO's business.  In the end, I held onto my shares after determining the punishment didn't fit the crime.  Now, after digging into MAKO's reassuring third quarter results, I'm tempted to add to my position shares trading near 52-week-lows.

Lynch on mutual funds: "Equity mutual funds are the perfect solution for people who want to own stocks without doing their own research."

Long an advocate of diversification, Lynch recognizes picking individual stocks isn't for everyone.  If you don't have time to perform your own research but still agree stocks represent the best long-term vehicle for building wealth, no-load mutual funds are your saving grace.  If you need help picking the right fund, the Motley Fool's Mutual Fund Center is a great place to start.

The Foolish bottom line

It's no coincidence the best advice is usually the hardest to follow.  Whether you the prefer the classic thoughts of Benjamin Graham or favor the modern insights of Peter Lynch, you'll be forced to confront the difficult task of exploring what it takes to deny your human nature and succeed as a Foolish long-term investor.


Steve Symington owns shares of MAKO Surgical and Under Armour.  The Motley Fool owns shares of Citigroup Inc , MAKO Surgical , and Under Armour. Motley Fool newsletter services recommend MAKO Surgical and Under Armour. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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