The Secrets of Successful Investing
Peter Lynch’s Almighty Crayon
August 2007 By Denny Hatch
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In the News
Credit Time Bomb Ticked, but Few HeardHow Missed Signs Contributed to a Mortgage Meltdown
As far back as 2001, advocates for low-income homeowners had argued that mortgage providers were making loans to borrowers without regard to their ability to repay. Many could not even scrape together the money for a down payment and were being approved with little or no documentation of their income or assets.
—Nelson D. Schwartz and Vikas Bajaj, The New York Times, August 19, 2007
OVER THEIR HEADS: Small Investors, Too, Get Nailed by Arcane Trades
—The Wall Street Journal, August 14, 2007
INVESTORS MULL HOW TO GET OUT OF HEDGE FUNDS: Market Turmoil Highlights Notoriously Tricky Rules for Redeeming Shares.
—The Wall Street Journal, August 15, 2007
The words “over their heads” and “tricky” caught my attention.
Investors are being hosed these days by Wall Street sharpies that have come up with highly complex, tricky and incomprehensible schemes that are over everyone’s head—including those that dreamed them up.
You and I are being hosed by these sharpies, too. They cried “WOLF”—just as they did in the 1980 Savings & Loan Crisis—and the federal government and central banks have injected billions into the markets. As taxpayers, we are bailing out the greedy, incompetent bastards.
If you read nothing else this week or this month (or this year), commit to memory the following advice from Peter Lynch, the retired wizard of Fidelity Investments:
Never invest in any idea you can’t illustrate with a crayon.
A Quick History of the Subprime Mortgage Mess
In the August 15 edition of The Wall Street Journal, Aaron Lucchetti and Serena Ng reported the spark that ignited the worldwide economic conflagration that we are seeing today:
In 2000, Standard & Poor’s made a decision about an arcane corner of the mortgage market. It said a type of mortgage that involves a “piggyback,” where borrowers simultaneously take out a second loan for the down payment, was no more likely to default than a standard mortgage.
While its pronouncement went unnoticed outside the mortgage world, piggybacks soon were part of a movement that transformed America’s home-loan industry: a boom in “subprime” mortgages taken out by buyers with weak credit.
In other words, it was okay for people with no money that wanted to buy a home to borrow money for the down payment and then borrow more money for a mortgage.
To encourage home ownership—the great American dream—the patriotic mortgage companies came up with the idea of a very low “teaser” fixed rate that automatically turned into a variable rate mortgage after a year or two. Thus a starting rate of 6.6% winds up at 9.6% in a few years.
Takeaway Points to Consider:
* “Never invest in any idea you can’t illustrate with a crayon.”—Peter Lynch
* “Go for a business that any idiot can run—because sooner or later, any idiot probably is going to run it.”
—Peter Lynch
* This past July, the stock market rose on news that June sales of Wal-Mart beat Wall Street’s expectations. My wife, Peggy, who handles all the family finances shook her head in disbelief. “Wal-Mart customers are the measure of consumer confidence and a reason for stocks to go up?” she muttered. “This is preposterous!”
* Peggy, as usual, was spot-on. In August, shares in Wal-Mart dropped 5% on news that earnings were down for July. A huge price-cutting campaign at Wal-Mart designed to prime the sales pump failed because of the rocky housing market and the high cost of gasoline. “Many customers are running out of money at the end of the month,” said H. Lee Scott, Jr., the chief executive of Wal-Mart.
* If your business model is pinned to people that “are running out of money at the end of the month” and cannot pay their bills, change the business model or update your résumé and send it out.
* Of the seven key copy drivers, the emotional hot buttons that change behavior, greed is the most powerful.
* Never invest in something that you are uncomfortable with. Remember how Warren Buffett was reviled as an old fuddy-duddy because he refused to invest in dot-com companies because he did not understand the business model and nobody was making any money.
* Some corporations and mutual funds are fine investments. As an institution, Wall Street stinks.
Web Sites Related to Today's Edition:
Q&A: Peter Lynch on Investing in Volatile Marketshttp://tinyurl.com/5qkhe
Peter Lynch’s Principles
http://tinyurl.com/yqglca
Bear Stearns
http://www.bearstearns.com/
Warren Buffett’s Berkshire Hathaway, Inc.
http://www.berkshirehathaway.com
Warren Buffett’s Letters to Shareholders
http://www.berkshirehathaway.com/letters/letters.html
Companies Mentioned:
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