When I was first learning how to drive, my dad taught me a valuable strategy for deciding when to make a right turn at a stop sign.
He said new drivers often make the mistake of turning at the first possible opening in traffic. A better strategy is to look farther down the road because usually there’s a wider opening that makes for an easier, slower turn:
By having a long-term vision, you can see farther down the road and identify the best opening.
This illustrates the advantage of long-term vision in driving, but this same principle applies to investing.
The Fallacy of Short-term Thinking
When I first started investing, I thought the fastest way to grow my money was through buying and selling individual stocks. I would pick a stock, hold it for a few months until it went up a bit, then sell it. I had a short-term vision.
What I didn’t realize was how much money I was actually losing in the form of trading fees. Each time I bought a stock, I paid $8.99 Each time I sold, another $8.99 went out the door. This was essentially canceling out any gains.
This finding has showed up in numerous investment studies. In general, active traders severely under-perform the market due to incurring high transaction costs. Even the traders who use no-fee apps like Robinhood typically under-perform due to poor market timing and short-term-gain taxes.
The Knowledge of Warren Buffett
As an investor, you can do yourself a favor by drawing upon the wisdom of investor Warren Buffett, who is a famous long-term thinker.
In reference to Berkshire Hathaway’s investment philosophy, Buffett says,
“Our favorite holding period is forever.”
This strategy has paid off nicely for him over the years:
This long-term perspective is the reason that Warren, along with his partner Charlie Munger, is able to buy stocks during market crashes when most investors are selling.
While most investors focus on returns over the next 30 days, Buffett is looking at the next 30 years. That’s his advantage.
In the short-term, investing in stocks can be risky.
In one of my favorite investment books,Stocks for the Long Run, Jeremy Siegel explains:
“In the short run, however, stock returns are very volatile, driven by changes in earnings, interest rates, risk, and uncertainty, as well as psychological factors, such as optimism and pessimism as well as fear and greed.”
If you’re someone who has a short investment horizon, this can be scary. In fact, the fear of losing money causes many people to avoid investing entirely.