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Q&A: Peter Lynch on Investing in Volatile Markets
Q: What do you want people to know who may be nervous about the market?

A: I’ve been looking at stocks professionally for over 32 years and have seen many difficult times – the market crash of 1987 (a 23% decline for the Dow in one day) and 6 recessions. Throughout history, there have been other difficult times. Depressions, the rise and fall of communism, the rise of free-market economies and failing banking systems. The September 11th tragedy was horrific for the country, but it is not the scariest time I’ve gone through in the stock market. We have a number of buffers in the economy and a lot of strong elements to help us continue to prosper. For example, Social Security payments are wonderful and unemployment compensation is great. The federal government had been running a surplus going into the 2001 recession. Sixty-nine percent of people own their homes. Housing prices are very firm; they’ve been up for the last few years. All of this helps the economy.

Q: What would you tell investors who have watched the value of their portfolios slide with the downturn in the markets?

A: I’d say the same things I said 10 months ago, the same things I said 10 years ago. The stock market is a volatile animal. There have been some traumatic declines in the stock market in the last year. Historically we have a decline of 10% or more about once every two years. That’s the nature of the market, even in good markets we have declines, and trying to predict its direction over the near term is an exercise in futility. Behind all the smoke and noise on the market’s surface, it’s important to remember that companies – small, medium and large – make up the market’s backbone. And corporate earnings drive stock prices. If you look at the 500 companies in the S&P 500®, despite 10 recessions since WW II, earnings have grown 7% annually. That’s a pretty good track record.

Q: What is the official definition of a market correction and bear market?

A: I get a lot of questions regarding the differences in the major declines in the stock market. A correction is nothing more than a Wall Street euphemism for losing a lot of money very rapidly. While it is valuable to debate why it happens, I think the most important thing to remember is that it is normal. That’s right, normal. Just think about how often the market moves like that. Since 1970, we’ve had 21 of these corrections – or drops – of 10% or more. Bear markets, which are decidedly less frequent than corrections, are defined as declines of 20% or more. Investors have experienced 11 bear markets in the last 50 years, based on intraday extremes in the S&P 500®. Investors who understand the fundamentals of the market don’t panic or pull out when we experience declines, because over the long term they know the stock market is the place to be.

Q: You always say to invest for the long-term. What do you mean by long-term investing?

A: A lot of people think long-term investing is three weeks from next Wednesday, but when I talk about long-term investing I mean 5, 10, 20 years. During that length of time the market can experience ups and downs due to what I call “background noise.” Events occur – hurricanes, wars, political instability, currency and bank crises – that make investors nervous and cause market volatility. It does get nasty at times, but it shouldn’t cloud investors’ judgments about thinking long-term. The key organ here is your stomach. Everyone has the brainpower, but not everyone has the stomach for it.

Q: You have said volatile markets underscore the need for diversification. Has anything changed that would alter your position on diversification?

A: Diversification has and always will be a critical component to investing wisely. Here’s an example: Of the 21 years in which stocks have had negative returns, medium-term government bonds had positive returns in 19 of them. I’m certainly not saying that bonds perform better than stocks, because we know over the long-term it’s not the case. But it makes a pretty good argument for diversifying into a wide range of equities, bonds and other asset classes if you think the market is in for tough times. And don’t get caught in the trap of false diversification within equities. A lot of people bought a number of technology funds and technology stocks but that constituted their entire equity holdings. When the Nasdaq declined, all those equity holdings went down together.

Q: Any parting thoughts for investors?

A: A couple of things. First, if you’re going to need money within 12 months to pay for a wedding or put a down payment on a house, the stock market is not the place to be. You can flip a coin over where the market is headed over the next year. I have no idea whether the next 1,000 points for the Dow or Nasdaq will be in positive or negative territory. But if you’re in the market for the long haul – 5, 10, or 20 years – then time is on your side and you should stick to your long-term investment plan. I would argue that the next 10,000 and 20,000 points for the market will be up. That’s been the long-term trend. The bottom line is to have a responsible plan for your investments and know what you own and why you own it. There’s too much at stake not to.

Past performance is no guarantee of future results.

Diversification does not ensure a profit or guarantee against loss in a declining market.

Mr. Lynch’s comments do not necessarily reflect the views or opinions of Fidelity Management & Research Company or the Fidelity Funds and should not be used or construed as a recommendation or investment advice.

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