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Don’t do something, just stand there!

Mark LaMonica, CFA  |  26 Aug 2020Text size  Decrease  Increase  |  
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Warren Buffett has said that his favourite holding period is forever. He understands that investors often overemphasise the importance of recent events, rushing into hot stocks when they’re overpriced and fleeing from market downturns. Investors can fight this common error by focusing on long-term lessons and long-term performance.

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Distinguishing between what you buy and where you buy it is crucial. Since buying a share makes you a partial owner of a company, the stock market is simply a means to purchase and sell shares. It is a marketplace that connects buyers and sellers. A key benefit of stock investing is liquidity. An asset is considered liquid if you can buy and sell it quickly without any meaningful drop in its price. This is attractive for investors because they can quickly convert a share into cash. To facilitate this, it is necessary to have constant price discovery. In other words, both buyers and sellers need to know the price of shares in order to make both sides comfortable enough to transact. That is the role of the stock market and market participants.

Liquidity is crucial when it comes to distinguishing between investing in a company that trades on the stock market and buying an investment property, or a small business. Imagine a world where you constantly knew exactly what someone would pay for your house and you had the ability to sell it to them in minutes for an insignificant commission. It would not be long before this constant flow of information would start to change your behaviour. The ability to check the price doesn’t mean you would always do it. But you would probably check when there were large price swings, possibly caused in part by your friends, family and the media weighing in. The constant price discovery and the ease of transacting would amplify the fear and greed of market participants. And fear and greed cause people to act when it is generally in their best interest to do nothing. Constantly buying and selling investment properties or small businesses would be a mistake. Yet many people think “playing” the market through continual trading is an effective approach for building long-term wealth.

The fact that you can do something doesn’t mean it is a good idea. Maybe you are a savvy trader who can enter and exit positions at just the right time. Chances are you are not. At Morningstar we advocate a long-term investing approach. Taking a patient, long-term view helps us ride out the market’s ups and downs and seize on the opportunities when they arise. We know that investors often overemphasise the importance of recent events, rushing into hot stocks when they’re overpriced and fleeing from market downturns. We fight this common error by focusing on long-term lessons and long-term performance.

Being a Morningstar Investor means investing for the long-term. Learn what else we believe by reading the Morningstar Guide to Investing.

is a product manager, individual investor, Australia.

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