Peter Lynch wants everyone to look inside themselves first before investing in any stocks. He came out with 3 important questions that will evaluate whether your situation is suitable for investing (from his book, “One Up On Wall Street“). I find it very apt to share with you, especially if you are intending to play stocks the very first time. These 3 questions are the very first few questions you have to ask yourself. Sadly, many people’s first question to ask is “what stock to buy?”. In fact, you should NEVER NEVER ask this question.
Question 1: Do I own a house?
The first question to ask is “Do I own a house?” The reason Peter gave was that “99 cases out of 100, a house is a money-maker”. He is pretty sure that a house is the very first investment everyone should make because of the high degree of certainty that the investment will make money for almost everyone. He explained and substantiated his stance why most people are more suitable for investing in real estate than stocks:
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- High Leverage – with just 20% downpayment or lower, you control a large asset. Besides housing loan, what other loans are you able to get a few hundred thousands dollars?
- No Margin Call – If you leveraged in stocks and the your stock price drops, you may need to make a margin call (to top up money). There’s is no margin call even if your house price falls.
- Federal Tax Deduction – In U.S., you even receive tax deduction for housing loans.
- No Panic – Unlike stocks, you do not dump a house when there is bad news. You sell stocks when stock market crash, but you do not really sell your house when real estate market plunge.
- Statistically longer holding period – Houses are own by the same person for 7 years on average. 87% of stocks in NYSE are held only for a year. And we know assets take time to grow.
- More Knowledgeable – Most people have knowledge over houses than stocks. Peter claimed that it is a skill passed down from our parents because we see them buy houses and negotiate prices. We are more likely to see a crack on the ceiling than spotting a mistake on a company’s balance sheet.
Question 2: Do I need the money?
So now you own a house. Do you have extra money to invest in stocks? If you do not have then stay away from the stock market. This is because you do not want to gamble away the money that need to pay off important things in the near future, like your children’s education. The consequences will be very high. In fact, investing with money that you need will actually worsen your decision-making, which means there’s a higher chance to lose money.
Question 3: Do I have the personal qualities it takes to succeed?
This is my favourite question because I believe not everyone is suited to invest in stocks. Peter’s list of qualities needed are patience, self-reliance, common sense, a tolerance for pain, open-mindedness, detachment, persistence, humility, flexibility, a willingness to do independent research, an equal willingness to admit to mistakes, and the ability to ignore general panic. That’s a pretty long list. Do you have most of them? I think one of the most important qualities to have is the ability to control emotions. One can never use emotions to make investment decisions. Gut feeling do not really work well in the stock market. Many people mistook themselves as “long term investors” and “contrarian investors”. Peter said, “some have fancied themselves as “long-term investors”, but only until the next big drop (or tiny gain), at which point they quickly become short-term investos and sell out for huge losses or the occassional minuscule profit.” “Some have fancied themselves as contrarians, believing that they can profit by zigging when the rest of the world are zagging, but it didn’t occur to them to become contrarian until that idea had already gotten so popular that contrarianism became the accepted view.”