The modern market is driven by short-term incentives, with hedge funds and pod shops trading based on quarterly estimates. This creates volatility and mispricing. An investor who can withstand short-term underperformance and maintain a multi-year view can exploit these structural inefficiencies.

Contrary to the 'hold forever' value investing trope, a three-year period of underperformance is a strong signal that your initial thesis was flawed. It's better to admit the mistake and reallocate capital than to stubbornly wait for the market to agree with you.

AQR's Cliff Asnes highlights that a prolonged period of underperformance is psychologically and professionally more damaging than a sharper, shorter drop. Enduring a multi-year drawdown erodes client confidence and forces painful business decisions, even if the manager's conviction in their strategy remains high.

The goal of diversification is to hold assets that behave differently. By design, some part of your portfolio will likely be underperforming at all times. Accepting this discomfort is a key feature of a well-constructed portfolio, not a bug to be fixed.

The sign of a working diversification strategy is having something in your portfolio that you're unhappy with. Chasing winners by selling the laggard is a common mistake that leads to buying high and selling low. The discomfort of holding an underperformer is proof the strategy is functioning as intended, not that it's failing.

Historical analysis of investors like Ben Graham and Charlie Munger reveals a consistent pattern: significant, multi-year periods of lagging the market are not an anomaly but a necessary part of a successful long-term strategy. This reality demands structuring your firm and mindset for inevitable pain.

We focus on how to win, but failure is inevitable. How you react to loss determines long-term success. Losing money triggers irrational behavior—chasing losses or getting emotional—that derails any sound strategy. Mastering the emotional response to downswings is the real key.

John Bogle's wisdom holds that the optimal investment strategy isn't based on historical performance but on what deeply resonates with your core beliefs. This ensures you'll stick with it during inevitable downturns, preventing the performance-destroying behavior of return chasing.

Even long-term winning funds will likely underperform their benchmarks in about half of all years. A Vanguard study of funds that beat the market over 15 years found 94% of them still underperformed in at least five of those years. This means selling based on a few years of poor returns is a flawed strategy.