Peter Lynch was an exceptional investor. He took over the Fidelity Magellan fund in 1977 and over the next 13 years he increased the assets under management from $18 million to $14 billion. This was not just a triumph of marketing because over this period, he averaged a return of over 29% a year, doubling the return of the S&P 500.

After that introduction, I’m reminded of an interview given by Allen Iverson after he won the NBA MVP in 2001. He was asked to compare himself to Michael Jordan and he reacted with horror: “There is no way I’m going to compare myself to MJ!” Similarly, I’m not going to put myself in the league as Peter Lynch.

But he also gave a spectacularly awful piece of advice: “Invest in what you know.”

This is probably an example of a great player who isn’t a great coach. It seems likely that Peter Lynch had great investing intuition and when he “knew” something, it was actually something worth knowing. Most people have no such insights. This isn’t just because, to misquote G.H. Hardy from “A Mathematician’s Apology”, most people have no real talents at all. The problem is that almost any such fundamental insights are exactly of the type that the market has already priced in. Your ability to process public information better than the market is going to be poor.

This type of investing is probably worse than useless, actively directing investors into stocks that they think they know but actually have missed an important point that the market has already priced in.

Trading on private, non-public information might work better but there are two problems with that as well. First, most of the edge will be in the sort of information that would be considered “inside” information. Trading on this is illegal. Also, even if your information is not privileged, it is very bad diversification to invest in a company you work for. The correlation between unemployment and stock price won’t be in your favor.

The good news is that you don’t have to play that game. Stock picking is hard, but investing is not a game where you get extra points for playing on hard mode. The equity risk premium, stocks go up, is probably the most well supported empirical fact in investing. The volatility risk premium, options are overpriced, has nearly as much evidence behind it. A simple portfolio that incorporates these two effects is available to everyone.

Investing in “what you know” might produce the occasional big winner and accompanying validation, but investing in factors will win in the end. Unless you are really Peter Lynch of course…

Disclaimer

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