The 3-Year Rule: When to Admit You're Wrong About a Stock

Every portfolio manager faces the same uncomfortable question: when do you admit a position isn't working and move on? Hold too long, and you compound mistakes with opportunity cost. Cut too early, and you abandon positions right before they vindicate your thesis. After two decades managing equity portfolios, we've developed a framework that brings discipline to this decision without relying on arbitrary stop-losses or emotional capitulation.

The answer, we've found, is three years. Not two, not five—three years represents the optimal window for an investment thesis to play out whilst avoiding the sunk cost fallacy that keeps bad positions alive indefinitely. This isn't intuition. It's pattern recognition from thousands of portfolio decisions, supported by data on how long genuine turnarounds take versus how quickly permanent impairments reveal themselves.

Why Three Years?

The three-year timeframe emerged from observing two competing realities in equity markets. First, genuine business transformations take longer than most investors expect. A new CEO needs 12-18 months to assess the situation, another 12 months to implement changes, and another year for those changes to flow through to financial results. That's three years minimum before you can judge whether strategic shifts are working.

Second, three years provides enough market cycles to distinguish between temporary setbacks and permanent deterioration. A business facing cyclical headwinds might underperform for 18-24 months. But if performance hasn't improved after three full years—through various market conditions, multiple earnings seasons, and several strategic adjustments—the problem is likely structural, not cyclical.

Consider the mathematics of opportunity cost. Money locked in an underperforming position for three years earning 0% annual returns while the market delivers 10% annually costs you 33% in relative performance. That's painful but recoverable with strong subsequent performance. Wait five years at zero return while the market compounds at 10%, and you're down 61% relative to benchmark—a deficit that requires exceptional returns to overcome even if the position eventually works.

The Test Applied

Let's examine how the three-year rule would have worked across several real-world scenarios from the past decade.

Intel presents a clear case study. Investors buying in early 2018 expected the semiconductor giant to maintain manufacturing leadership whilst expanding into new markets. By early 2021—three years later—Intel had fallen two generations behind TSMC in process technology, lost Apple's processor business, and watched market share erode to AMD. The fundamental thesis (manufacturing superiority) had been proven wrong. Investors who recognized this at the three-year mark and reallocated to TSMC or Nvidia would have recovered losses and then some.

Contrast that with Meta Platforms. Investors buying in late 2021 faced brutal losses through 2022 as metaverse spending exploded and revenue growth stalled. By late 2024—three years later—the thesis had evolved but remained intact. The core social networking business proved durable, AI investments began driving engagement, and management demonstrated cost discipline. Selling at the three-year mark would have meant missing the subsequent recovery. The difference? Meta's fundamental business model remained sound; execution had temporarily faltered but could be fixed.

General Electric offers perhaps the most instructive example. Investors buying in 2015 believed the industrial conglomerate would successfully streamline operations and improve returns. Three years later in 2018, it was clear the company faced far deeper problems: accounting irregularities, massive pension underfunding, and structural challenges across multiple divisions. The thesis wasn't temporarily wrong—it was fundamentally flawed. The three-year mark provided clear evidence that management couldn't execute the turnaround, and the business model itself was broken.

Boeing demonstrates the three-year rule's nuance. Investors holding through the 737 MAX crisis starting in 2019 faced three brutal years of groundings, investigations, and production halts. But by 2022, while Boeing hadn't fully recovered, the fundamental thesis remained valid: duopoly position in commercial aircraft, multi-decade backlog, and no viable competitor emerging. The crisis was severe but not permanent. This required distinguishing between "business temporarily broken" versus "business model broken"—a critical distinction the three-year window helps clarify.

When the Rule Breaks Down

The three-year framework isn't absolute. Several situations demand faster action:

Fraud or accounting irregularities require immediate exit. If management has been dishonest about fundamentals, your entire thesis rests on false information. There's no "three years to see if fraud works out."

Permanent technological displacement demands quick recognition. When a superior technology emerges that fundamentally obsoletes your holding's business model, don't wait three years for confirmation. Blockbuster didn't need three years to prove streaming would destroy video rental. Neither did Kodak need three years to confirm digital photography's threat.

Regulatory or legal threats that genuinely imperil the business model require swift reassessment. If government action credibly threatens to ban or severely restrict core operations, the three-year window may be irrelevant. Tobacco companies in the 1990s faced such threats. So did Chinese education companies in 2021 when Beijing banned for-profit tutoring.

Capital structure problems—excessive leverage approaching maturity with no refinancing options—can't wait three years. Bankruptcy doesn't respect holding period rules. If debt covenants are breached or liquidity has evaporated, exit before the inevitable restructuring.

Conversely, some situations merit extending beyond three years:

Deep value situations in out-of-favor sectors often take 4-5 years to work. Energy stocks bought in 2016 needed until 2021 to deliver meaningful returns as the entire sector was shunned. Patience beyond three years was warranted because the thesis (eventual commodity recovery) remained intact even as timing proved longer than expected.

Emerging market positions facing temporary currency or political crises may need extended timeframes. A 2015 investment in Brazilian equities required holding through the Dilma Rousseff impeachment, Lava Jato scandal, and currency collapse. The three-year mark in 2018 arrived during continued turmoil, but the underlying businesses remained sound. This required judgment about whether issues were transitional or permanent.

Implementing the Framework

The three-year rule works best when combined with systematic evaluation triggers. We use quarterly portfolio reviews to assess positions approaching the three-year mark, asking five specific questions:

Has the original investment thesis been validated, invalidated, or simply delayed? If delayed, why? Can management articulate what's changed and what hasn't?

Have competitive dynamics evolved in ways that undermine the thesis? Has a new competitor emerged, or has an existing one deployed a superior strategy?

Is current underperformance cyclical or structural? Will normalized earnings power return when conditions improve, or has the business model been permanently impaired?

Has management demonstrated the capability to execute? Are they adapting to challenges, or stubbornly pursuing failed strategies?

What's the opportunity cost? What could we own instead with this capital, and what's the probability that generates better returns than holding?

These questions force analytical rigor rather than emotional attachment. The goal isn't mechanical rule-following but disciplined evaluation after enough time has passed to judge whether your original thesis was correct.

Documentation matters enormously. At purchase, write down specifically why you're buying: what has to happen for the position to work, what would invalidate the thesis, and what timeframe seems reasonable. This contemporaneous record prevents hindsight bias from contaminating later evaluation. Three years later, pull out that document and honestly assess whether events unfolded as expected.

We also track "thesis drift"—the tendency to unconsciously modify your original rationale to justify holding a losing position. If your reason for owning a stock today differs meaningfully from why you bought it three years ago, you're probably rationalizing rather than analyzing. Either formally update the thesis with new information or admit the original idea didn't work and move on.

The Behavioral Challenge

The three-year rule's greatest value isn't analytical—it's behavioral. It provides permission to admit mistakes without feeling like a quitter. Loss aversion makes cutting positions psychologically painful. You're crystallizing a loss, admitting you were wrong, and potentially watching the stock recover after you sell. That combination of pain makes investors cling to losers far longer than rational analysis would justify.

A predetermined timeframe removes some of that paralysis. If you've committed to a three-year evaluation window upfront, reaching that mark creates natural decision points. You're not "giving up"—you're following a disciplined process that respects both the time required for theses to work and the reality that capital has opportunity cost.

This also helps client communication. "We gave this position three years to demonstrate the turnaround was progressing, and here's what we learned" is a much stronger narrative than "We sold because it went down" or "We held because we still believe." The timeframe creates accountability for both entering and exiting positions.

What About Stop Losses?

Some advisers prefer mechanical stop-losses: sell automatically if a position declines 20% or 30% from purchase. We've never found this approach useful for fundamental long-term investors. Price declines alone tell you nothing about whether your thesis was right or wrong. Some of our best returns came from positions that initially fell 40%+ before fundamentals emerged. Conversely, some positions drifted sideways for years before collapsing—no stop-loss would have helped.

The three-year rule focuses on thesis validation rather than price movement. If you bought a stock at $100 and it's now at $70 after three years, that price decline is relevant only insofar as it reflects business performance. If fundamentals have actually improved but market sentiment hasn't caught up, the decline is noise. If fundamentals have deteriorated alongside price, that's signal. Stop-losses can't distinguish between the two.

That said, extreme price declines (over 50%) within short periods (6-12 months) demand immediate thesis review regardless of the three-year window. When markets price something for near-term disaster, sometimes they're right. Don't wait three years to confirm bankruptcy.

Building the Discipline

For advisers adopting this framework, start with new positions rather than retroactively applying it to existing holdings. For each new purchase, document:

The specific thesis: what has to happen for this to work. The expected timeframe: three years unless there's a compelling reason for longer or shorter. The invalidation criteria: what would prove you wrong. The evaluation date: exactly three years from purchase.

Then in your calendar, schedule a formal review exactly three years out. This review isn't optional or ad-hoc. It's a commitment made at purchase: we will comprehensively re-evaluate this thesis in three years whether the position is winning or losing.

For existing positions, triage based on how long you've held them. Positions held less than a year generally need more time. Positions held 2-3 years should be evaluated immediately using the three-year framework. Positions held 4+ years deserve scrutiny about why you're still holding—at this point, they should have definitively worked or been cut already.

The three-year rule isn't about arbitrary timeframes. It's about matching patience to the realistic speed of business change whilst avoiding the permanence trap of holding losers indefinitely. It forces the uncomfortable question every portfolio manager must answer: am I holding this position because the thesis remains intact, or because I'm hoping to avoid admitting I was wrong?

After three years, you have enough evidence to answer honestly. The discipline is having the answer ready, documented, and defensible—whether that answer is "hold" or "sell."