After underperforming by 40 points in 1999, Barron's questioned Buffett's ability. Most investors grew fearful and sold, just before Berkshire Hathaway doubled over the next decade while the S&P 500 remained flat. This highlights the danger of following herd sentiment during periods of poor performance.
A Vanguard study of over 2,000 active funds revealed a stark reality: even among the top quartile that survived and outperformed long-term, 95% still lagged their benchmark in at least five years out of the period studied. This proves that frequent underperformance is a normal feature of a winning strategy.
Most investors evaluate performance over a few years, but financial economist Ken French states it's 'crazy' to draw inferences from three, five, or even ten-year periods for an active fund. Shorter timeframes are heavily influenced by randomness and luck, leading to flawed investment decisions.
Calendar year results are arbitrary and can be misleading. A more robust method is to analyze rolling returns, which evaluate performance over fixed periods (e.g., five years) from many different starting points. This method reveals a strategy's true consistency by smoothing out short-term market noise.