Friday was a rough day for investors. The FTSE 100 index sank over 3%. A similar story unfolded in many global indexes as concerns grew over the latest Covid variant. Is this a blip or a taste of a full-on stock market crash?
“More speculation than the 1920s. More overvaluation than the 1990s. More geopolitical and economic strife than the 1970s.” This warning was tweeted earlier in the month by infamous Big Short hedge fund manager Michael Burry. He’s certainly a major stock market crash.
Should I be nervous? Well, there’s always going to be something to worry about as an investor. My news feeds add to that list of worries daily. New Covid variants. Inflation running wild. Brexit. Meme stock madness. China-Taiwan tensions.
While, of course, a stock market crash is concerning, I try to keep emotion out of my investment decisions. I follow some basic principles of legendary investor Peter Lynch to stay calm.
Peter Lynch’s philosophy
Peter Lynch averaged an incredible 29% annualised return between 1977 and 1990 while managing the Magellan Fund. He didn’t bother with economic predictions but acknowledges that many investors let emotions take charge when prices plummet. Lynch used three basic investment principles to guide investors like me through the highs and lows.
The first was “if you can’t explain it to a 10-year-old in 2 minutes or less, don’t own it.” Lynch highlighted the importance of buying shares in companies we understand. Without this philosophy, any changes in the share price could lead me to hasty investment decisions.
Then there was “never invest in a company without understanding its finances. The biggest losses in stocks come from companies with poor balance sheets.” I always do my homework. A company with strong cash flows will have a greater chance of surviving unfavourable economic conditions.
And finally there’s “the key organ to use in the stock market is your stomach, not your brain.” Stock market crashes are unpredictable, as so is the short-term performance of any stock. But stock market performance over 10-20 years is much more predictable. That’s why it’s important to think long term when buying shares in a company. If a stock he owned suddenly dropped in price, he would evaluate if his assessment of the company had changed. If not, he took advantage of a discounted share price of a company he believed in to buy more for the long term.
So what does this mean for me?
Friday was a mere blip rather than a stock market crash. However, BP shed over 7% of its value in a single day and Lloyds Banking Group plunged over 4%. Before Friday, I believed in the long-term earnings prospects of both companies. In fact I would have argued that they were potentially undervalued. I now see an opportunity to invest in quality companies at a discounted price compared to the previous day. Of course both BP and Lloyds could see their share prices fall further if the variant leads to more lockdowns.
I plan to shut out the noise and invest in quality companies with strong balance sheets for the long term. With this attitude, stock market crashes and volatility becomes less of a worry and simply part of the investing lifecycle.