In his book on the Bin Laden raid, Navy SEAL Mark Owen writes that "one of the key lessons learned early on in a SEAL's career was the ability to be comfortable being uncomfortable."

Being cold, wet, hungry, and tired is a normal part of the process, Owen writes. Rather than trying to avoid it, they learn to deal with it.

That's probably a good lesson for most things in life, including investing.

Want to be a great investor over the long run? Get used to being uncomfortable.

Research Affiliates, one of the smartest market research firms around, just did a big study on 45 years of mutual fund returns.

The results were depressing. Of 350 mutual funds available to investors in 1970, only 100 survived through 2014. The other 250 closed, or were merged with other funds. Of the 100 that survived, 45 beat the market over the whole period; 42 of them beat it by less than two percentage points per year.

But that's old news. What's remarkable was a characteristic of the three "superstar" funds that beat the market by more than 2 percentage points a year for 45 years. They spent, on average, a third of the time underperforming the market on a rolling three-year basis:

Source: Research Affiliates.

You can imagine the ridicule these managers went through when, for years on end, they lagged the market. Clients surely pulled money out of their funds. Journalists stopped calling them. Their personal pay likely plunged. It was uncomfortable.

But they still beat 99% of their peers over the long run.

This is a good display of four of important rules.

"History doesn't crawl; it leaps"
There are four types of investment returns:

  • Consistently bad.
  • Mostly bad and occasionally good.
  • Mostly decent and occasionally good.
  • Consistently good and fraudulent.

That's the complete list.

Look at the long-term history of great investors, and you'll find they occupy the third category. A disproportionate share of their overall gains come from a small number of investments. At last year's Berkshire Hathaway (BRK.B 0.79%) shareholders meeting, Warren Buffett noted that of the 400-500 stocks he'd invested in during his life, he's made most of his money on 10 of them. Same with Ben Graham, whose entire career success as an investor is tied to one stock: GEICO. Incredible opportunities – or luck – don't happen frequently enough to show up in annual returns. It's often middling performance for years, and then... wham. One event knocks it out of the park.

There's nothing special about a year
Yale economist Robert Shiller once noted the absurdity of racing to meet one-year goals. "I don't know why people keep using one year earnings," he said. "That is the time it takes the Earth to go around the sun. I don't see any other significance." 

Say a manager underperforms the market for 12 months, but by month 19, they're beating it. Who cares? Why is 12 months the official limit on measuring success? What gets dangerous is when a manager feels he needs to perform on a 12-month -- or quarterly -- basis, and starts doing all kinds of insane trading maneuvers to window-dress year-end returns.

You have to act differently if you want different returns
This seems obvious, but there's safety in numbers, and for most managers, there is more job security being consistently mediocre than being occasionally bad and occasionally great. Too many fund managers effectively run a high-fee index fund and aren't really trying to outperform. Like a SEAL, doing well over time means being comfortable being uncomfortable, straying from the crowd, and often lagging your benchmark.

Picking the right manager is insanely hard
Out of 350 funds, three did well over the 45-year period. Three. 0.85%. And how many investors were brave enough to stick with them for a long period of time? Few, I bet. Sometimes a manager's poor performance is really a sign he's incompetent. Other times, a smart manager is just going through a bad stretch. How do you know which is which? If there was an easy way to answer that, we'd all be rich. 

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