If there’s anything the pandemic has taught us as investors, it’s that we cannot predict what’s going to happen next. Trying to time the stock market can cost us and it will most of the time.
For the last 20 years or so, the S&P 500 has returned about 6% per year. But if you missed the best 20 days in the market over that time span, by for example selling out in declines and then reinvesting later, your annual return would shrink to 0.1%. Which is a useless piece of information but true in the sense that it makes one ponder.
The idea is that investing is not easy but timing the market or doing short-term trades all the time is worse. If investors can’t tolerate volatility, they’ll miss out on the power of compounding.
That’s why you should use the following mental trick whenever you think of buying a stock. Ask yourself:
Would I buy into this company if they would close the stock market the next day and not reopen it for five years?
It acts as a useful mental filter. You do not take yearly results too seriously, you discard your mediocre ideas, you stay away from things you don’t fully understand, and you care a lot about the price you pay. And when you do buy into a company, you will do so because you want to own it, not just because you want the stock to go up.
Which is a lot like buying a farm.
Farming goes through good times and devastating times. Every well-equipped farmer knows to expect the unexpected and so they take the bad times with equanimity. It’s just how it is because farmers cannot predict freakish weather or other adverse crop conditions. The weather is volatile, as is stock prices.
An intelligent farmer wouldn’t sell their entire farm—or “cut their position”—from a single year’s bad crop because they know that a single season matters little to the value of their farm. Likewise, they wouldn’t buy a new farm every few years, rebalance their farming portfolio every few months, nor would they expect to make a lot of money next week or next month when they buy a new farm. But despite the fact that the intrinsic value of a farm is exactly the same as the intrinsic value of a company listed on a stock exchange—the present value of the business’s future cash flow—this sit-on-your-ass behavior is very unusual with stock market investors.
The reason lies in one single difference between farming and the stock market. In farming, no one will walk up to your farm shouting prices every day. But this is exactly how the stock market works, and many investors react to it the wrong way. Rather than letting price volatility be a gift, they respond to what other investors are doing which is not at all how an intelligent farmer operates. If a neighboring farm owner sells their property at a low price, no way would the intelligent farmer rush to sell their property too. If anything, they would rather attempt to buy the neighboring farm at the bargain.
Therefore, use the simple mental trick of asking yourself if you would buy the stock you are considering if the stock market was to close for the next five years. It may help you from getting caught in the slump of something you don’t understand. And it helps you to invest more like an intelligent farmer.