Why Legendary Investor Peter Lynch Ignored Stock Market Crash Predictions, and Why You Should Too

Calls for a possible stock market crash have increased, with two high-profile investors recently sounding the alarm.

Michael Burry, who rose to prominence for rightly describing the collapse of the housing market, recently warned that the AI ​​bubble was about to burst. In an article on Burry has been a noisy bear, while short-circuiting Nvidia, Palantir Technologies, Micron technologyand other AI actions.

Billionaire investor Ray Dalio, meanwhile, also joined the bear party, warning that the AI ​​boom was showing classic signs of a bubble about to burst. At the Forbes Global CEO Conference in Singapore, Dalio highlighted how the combination of increasing debt used to finance the construction of AI infrastructure and rising interest rates could lead to a sharp market downturn. Meanwhile, on Bloomberg News, Dalio added that people starting to withdraw their investments, impose a wealth tax or have to repay loans could also trigger the bubble to burst.

Meanwhile, market experts have highlighted the S&P500 (^GSPC +0.59%) trading at valuations rarely seen in the past. The S&P 500’s cyclically adjusted PE (CAPE) ratio reached 40 for only the second time in history, the last time being just before the dot-com bubble burst. The valuation measure, created by Yale economist Robert Shiller, uses 10 years of inflation-adjusted S&P 500 earnings to smooth out the peaks and declines that accompany business cycles.

At the same time, the Buffett Indicator, named after famous investor Warren Buffett because it is one of his favorite valuation indicators, also reached an all-time high. This indicator measures the value of the entire U.S. stock market relative to the country’s gross domestic product (GDP). A figure above 120% is considered overvalued, while the ratio now exceeds 238%.

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How should investors prepare for a possible stock market crash?

If you’re worried about a possible stock market crash, I’d follow the advice of legendary investor Peter Lynch. He led Fidelity’s flagship Magellan fund from 1977 to 1990, generating an exceptional average annual return of more than 29% during that period.

In an essay appearing in the September 1995 issue of Value magazine, Lynch said, “Investors who were preparing for corrections or trying to anticipate corrections lost far more money than the corrections themselves lost.” »

In the article, Lynch went on to point out the mistake investors make when they try to hedge their investments with options or lighten their positions. He noted that if you invested $2,000 in the S&P 500 every year on January 1 since 1965, your average annual return would be 11% (I’m assuming that ends in 1994, given the article’s publication), while if you invested the same amount every year at the top of the market, your return would only drop to 10.6%.

Lynch added: “Whether your timing is good or bad. What matters is that you stay invested in stocks.”

What Lynch is essentially advocating is that investors ignore calls for any market correction or crash and stay disciplined by using a dollar-cost averaging strategy. I think the best way to do this is to use index exchange traded funds (ETFs), like Vanguard S&P 500 ETF (VOO +0.61%) Or Invesco QQQ Trust (QQQ +0.49%)who follows technological trends Nasdaq100 hint.

The reason I think these are the best investment options where the cost is constant also follows one of Lynch’s other big mantras of not selling your winners too early. Market-cap-weighted ETFs actually force investors to follow this advice, because when a company’s stocks outperform, they naturally make up a larger percentage of the fund.

So while it’s normal to be nervous when celebrity investors call for a stock market crash, remember that time in the market is worth more than market timing in the long run.