In my practice, I constantly warn clients against the seductive allure of short-term performance data. Among the most dangerous of these metrics is the “average 4-year return.” A four-year window is long enough to feel significant but is, in reality, almost perfectly designed to mislead. It captures a arbitrary slice of a market cycle, offering a narrative of performance that is often a mirage. It tells you more about recent market conditions than it does about a fund’s quality or a manager’s skill. Today, I will deconstruct why this specific timeframe is so deceptive, provide a realistic view of what returns to expect over such a period, and explain how to interpret this data without falling into common behavioral traps.
Table of Contents
The Four-Year Window: A Snapshot, Not a Film
A four-year period is not a market cycle. It is a phase within a cycle. The returns over any given 48-month period are overwhelmingly determined by the starting valuation of the market and the macroeconomic events that occurred during that specific window.
Consider these recent contrasting 4-year periods for the S&P 500:
- Period A (2016-2019): A period of steady, low-volatility growth. The annualized return was strong and positive.
- Period B (2018-2021): This period included a sharp Q4 2018 correction, the COVID-19 crash of March 2020, and the furious recovery and bull run that followed. The annualized return was exceptionally high, but the journey was terrifying.
- Period C (2020-2023): This period started at the bottom of the COVID crash, included a massive bull run, and then transitioned into a brutal bear market in 2022 driven by inflation and rate hikes. The annualized return was highly variable.
A fund’s 4-year return tells you the outcome of that specific journey, but it tells you nothing about whether the journey will repeat. Investing based on a 4-year return is like choosing a ship captain based on how he performed in the last storm without knowing what the next storm will look like.
The Deception of the “Average”
The term “average 4-year return” is a statistical fiction in the context of fund selection. There is no such thing as an “average” period. The market does not deliver mean returns over rolling 48-month increments; it delivers wildly variable outcomes based on the prevailing environment.
Furthermore, this average is subject to recency bias. Investors are naturally drawn to funds with stellar recent 4-year performance, which almost always means they have excelled in the most recent market regime. This leads to the classic error of performance chasing—buying high after the gains have already been made.
A Realistic Range of 4-Year Outcomes
Instead of an average, it is far more instructive to look at the potential range of outcomes for a diversified equity mutual fund over a 4-year horizon. This range is startlingly wide.
Table: Realistic 4-Year Annualized Return Scenarios for a U.S. Equity Mutual Fund
| Scenario | Macroeconomic Backdrop | Approx. 4-Year CAGR Range | Investor Psychology During Period |
|---|---|---|---|
| Secular Bull Market | Low inflation, expanding earnings, low rates. | +12% to +20%+ | Euphoria, complacency. |
| Secular Bear Market | Stagflation, contracting earnings, high rates. | -8% to -20%+ | Fear, panic, despair. |
| Cyclical Recovery | Post-recession, easy monetary policy. | +15% to +25%+ (off a low base) | Relief, optimism. |
| Sideways Grind | Economic uncertainty, valuation digestion. | -2% to +5% | Frustration, boredom. |
The Critical Takeaway: The 4-year return tells you which of these environments just occurred. It provides almost no predictive power about which environment will occur next.
The Active Management Mirage
This short-term performance window is where active fund managers shine in their marketing materials. A manager who overweighted technology from 2019-2023 might have a breathtaking 4-year return. This does not prove skill; it proves they were in the right place at the right time.
The brutal truth, as shown by decades of SPIVA (S&P Indices vs. Active) data, is that over longer periods (10+ years), the majority of active managers fail to beat their benchmark index. A strong 4-year run is often just luck, and it is impossible to distinguish luck from skill in such a short timeframe. The high fees of active management (often 0.70%+), however, are a guaranteed drag on your returns, regardless of the manager’s luck.
A Cost Calculation: The Silent Killer of Short-Term Performance
Let’s assume two funds achieve a gross return of 10% annually over a 4-year period.
- Fund A (Low-Cost Index Fund): Expense Ratio = 0.05%
- Fund B (Average Active Fund): Expense Ratio = 0.75%
The net annual returns are:
- Fund A Net Return: 10% – 0.05% = 9.95%
- Fund B Net Return: 10% – 0.75% = 9.25%
Now, let’s calculate the future value of a \text{\$50,000} investment in each over 4 years.
Fund A:
\text{FV}_A = \text{\$50,000} \times (1.0995)^{4} = \text{\$50,000} \times 1.4586 \approx \text{\$72,930}Fund B:
\text{FV}_B = \text{\$50,000} \times (1.0925)^{4} = \text{\$50,000} \times 1.4337 \approx \text{\$71,685}The Cost of Active Management (over just 4 years):
\text{\$72,930} - \text{\$71,685} = \text{\$1,245}Even in a best-case scenario where the active fund matches the index’s gross return, the higher fee costs the investor \text{\$1,245}. In reality, most active funds underperform their benchmark gross of fees, making the net outcome even worse.
How to Use 4-Year Return Data Intelligently (If At All)
You should not use this data for fund selection. Instead, use it for context and expectation setting.
- As a Reality Check: If a fund shows a 20%+ 4-year annualized return, understand that this is an aberration, not a new normal. It likely means the asset class is expensive and future returns over the next 4 years may be lower.
- To Assess Strategy Consistency: Look at how the fund performed relative to its benchmark over the period. Did it outperform by a little in a up market but get crushed in a down market? This tells you about its risk profile.
- To Gauge Your Own Risk Tolerance: The 4-year return number is a cold, hard result. Look at the annual returns within that period. Could you have stomached the drawdowns that occurred along the way to that result? This is more valuable than the final number itself.
My Final Counsel: Look Through the Windshield, Not the Rearview Mirror
The 4-year mutual fund return is a rearview mirror. It tells you where you’ve been, not where you are going. Basing investment decisions on it is a classic form of driving while looking backward—it inevitably leads to a crash.
Your investment process should be deliberately boring to avoid this trap:
- Focus on Asset Allocation: Your long-term returns will be determined by your mix of stocks, bonds, and other assets, not by picking the top-performing fund of the last four years.
- Prioritize Low Costs: Choose the lowest-cost vehicle that fits your asset allocation need. This is the variable you can control with certainty.
- Embrace Time Horizon: If your goal is less than 7-10 years away, a significant portion of your capital should not be in equities at all. The shorter your timeframe, the more vulnerable you are to the wild variability of 4-year returns.
Dismiss the allure of the short-term track record. The path to wealth is not found in chasing yesterday’s winners; it is found in building a low-cost, diversified portfolio and holding it with discipline through all types of 4-year periods—the glorious, the terrible, and the painfully boring. That is the only average that ultimately matters.
