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Know why you bought the stock

An overly emotional response by an investor could lead to hasty decisions, such as prematurely selling off stocks after an unexpected move.

According to investing legend Peter Lynch, selling a promising company too early can result in missing out on substantial gains.

“Your great mistakes are selling a good company, and then it doubles, it triples, it quadruples,” Lynch said during a CNBC interview in 2002.

When the host Louis Rukeyser asked him when an investor should sell, Lynch replied, “You ought to find out why you bought the stock.”

In essence, he stressed the importance of revisiting the initial reasons for investing in a company and staying attuned to its narrative. Lynch illustrated this concept using the example of Walmart.

“Ten years after [Walmart] went public, you could have bought the stock and made 500 times your money,” he remarked. “So you have to say to yourself: ‘In this stock, I have a 10-year story? A 20-year story?’ I’ll be able to write that down and follow that. That’s what I do.”

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Adopt a long-term perspective

To manage the emotional rollercoaster of daily market gyrations, a straightforward approach is to adopt a long-term perspective.

Warren Buffett, widely regarded the greatest investor of our time, once said, “The stock market is designed to transfer money from the active to the patient.” He encourages investors to buy and hold quality companies with durable competitive advantages, regardless of short-term market movements.

In fact, even Buffett, known as the Oracle of Omaha, has admitted the impossibility of predicting market movements.

During his company Berkshire Hathaway’s annual shareholders meeting in 2022, Buffett firmly rejected the idea of market timing.

“We haven't the faintest idea what the stock market is going to do when it opens on Monday — we never have,” he said.

“I don't think we've ever made a decision where either one of us has either said or been thinking: 'We should buy or sell based on what the market is going to do.’”

Instead, Buffett's approach centers on evaluating a business’ fundamentals. He is known for his patience, having famously said, “Our favorite holding period is forever.”

In other words, when it comes to building long-term wealth, time in the market beats timing the market.

Build your buffer before you buy

While we strive to remain composed, fluctuations in our brokerage accounts can be unnerving. This reaction is understandable, as we all rely on money for our daily needs.

Hence, before starting your investment journey, consider creating a financial cushion or emergency fund. This fund serves as a safeguard, ensuring that you have readily accessible cash to cover unexpected expenses, such as medical emergencies, car repairs, or sudden unemployment.

The primary objective of this fund is to provide financial security. It also offers peace of mind and aids in reducing emotional reactions in investment decisions. When you know your immediate financial needs are covered, you're less likely to make impulsive decisions, such as prematurely selling stocks during market dips due to sudden cash needs.

So, how substantial should this cushion be?

Personal finance expert Dave Ramsey suggests having an emergency fund that can cover three to six months worth of living expenses.

Of course, this amount may vary based on individual circumstances, such as job stability and personal financial obligations.

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About the Author

Jing Pan

Jing Pan

Investment Reporter

Jing is an investment reporter for MoneyWise. He is an avid advocate of investing for passive income. Despite the ups and downs he’s been through with the markets, Jing believes that you can generate a steadily increasing income stream by investing in high quality companies.

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Disclaimer

The content provided on Moneywise is information to help users become financially literate. It is neither tax nor legal advice, is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. Tax, investment and all other decisions should be made, as appropriate, only with guidance from a qualified professional. We make no representation or warranty of any kind, either express or implied, with respect to the data provided, the timeliness thereof, the results to be obtained by the use thereof or any other matter.