Don’t Be Fooled by a Five-Year Chart
The tension between recent performance and long-term compounding
In this post, the actual symbols traded and the strategy are irrelevant to the point I am trying to make. The objective is to illustrate how the pull of short-term performance creates a real tension when choosing superior long-term investments.
In the example below, the 5-year return on the left is the clear winner relative to the 5-year return on the right. If your natural framing is to focus on shorter-term performance, then you will almost always gravitate towards the investment on the left and ignore the one on the right.
However, both of these investments have long track records.
When we extend the horizon, the picture completely reverses. The investment below on the left is the clear winner by a significant margin over the one on the right.
The investment with the highest S2N Score, 78.45, and a 19.36% CAGR over 36 years is the one that would likely have been discarded based on its 5-year performance.
The best long-term investment is the one most investors would have ignored.
Concluding Thoughts
Nobody knows how the future will play out.
The strong-performing investment over the past 36 years may not continue to deliver the same results. Equally, the weaker long-term performer may improve. That uncertainty always exists.
What we do know is that the long-term winner adapted better across multiple market regimes and, as a result, compounded significantly more over time.
It would be too simplistic to say that one should always choose the investment with the strongest long-term track record. However, consistently favouring short-term performance over long-term evidence is unlikely to lead to better outcomes.
The only real justification for doing so is if you have a statistically robust way of identifying regime shifts ahead of time. Without that, you are more likely reacting to noise than capturing a durable edge.