Passing The Mirror Test
In the 4th chapter, the author says that there is no point in studying the financial section until and unless one has passed the so-called “Mirror Test". He says that before one buys a share of a company, three personal issues have to be addressed.
- Does he/she own a house?
- Does the investor have the unique qualities that lead to success in investing?
- Investor’s monetary usages and needs.
Owning a House
- Peter Lynch says that before buying a stock, one should buy a house because it is a bigger and safer investment that almost everyone makes. However, there are exceptions to this rule, but a home would be financially rewarding for its owner in most of the cases.
- He says that “It’s no accident that people who are geniuses in buying their houses are not efficient with their stock pickings. A house is entirely rigged in the homeowner’s favour. The banks let you acquire it for 20% down payment and even less in some cases, giving us the remarkable power of leverage.”
- Houses, like stocks, are most likely to be profitable when they’re held for a long period of time.
- People make money in the real estate market and lose money in the stock market as they spend months choosing their houses, and minutes choosing their stocks. They spend more time shopping for a good microwave oven than shopping for a good investment.
Need for Money
- The money that one wants to invest in stocks should be surplus, and if one is going to pay for their child's education in the next two or three years, the money should not be put into stocks. In other words, “Only invest what you could afford to lose without that loss having any effect on your daily life in the foreseeable future.”
- He also noted in his book that younger individuals who are living off inheritance and people who are living on a fixed income, especially ones who are old, should avoid investing in the stocks.
Does one have the right qualities to succeed?
The third question asked by Lynch to potential investors was, in a way, created to discourage those who don't possess the right character traits for jumping and investing in the market.
- According to the author there are a few absolute necessary qualities which are essential to be successful in creating wealth through stock investments. It includes 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.
- It is important to be able to make decisions without complete or perfect information. Things are almost never clear on Wall Street, or when they are, then it’s too late to profit from them.
Peter Lynch asks his potential investors to address the above three key issues. If one can answer 'Yes' to all of them, then they have successfully passed the mirror test and also possess the potential to become a good investor.