Focus on Absolute Performance

Most mutual fund investors fail to outperform the S&P 500 index over the long-term, after expenses are factored in. They accept this sub-par performance year in and year out without considering alternatives -- and the best one is index funds.

This acceptance comes from investors focusing on relative performance, when in fact, successful investors focus on absolute returns.

Market returns should not dictate your decisions
Investors who consider relative performance compare their results to the market's, or worse, other investors'. For good relative performance, they concentrate on imitating or outguessing others, and doing so, their efforts shift away from buying undervalued securities to an approach dictated by someone else.

Absolute performance, on the other hand, focuses investors on long-term results. Undervalued securities are purchased without considering market sentiment and instead on their own merits.

So undervalued securities often don't move in sync with the overall market. Absolute performance may result in an underperformance relative to the market indices, because those investors wait while the rest of the market is climbing.

Recipe for mistakes
Costly mistakes can happen when investors chase short-term relative performance benchmarks. Looking back at the dot-com bubble illustrates this point perfectly.

The news stories of individuals with no investing experience earning triple-digit returns inspired small and big investors alike to invest in anything rather than invest soundly. Instead of waiting for the right time, investors poured good money after bad in an effort to produce results like everyone else's, without considering fundamental analysis.

It didn't matter that companies like, (Nasdaq: AMZN  ) and Cisco (Nasdaq: CSCO  ) were not making profits in 2001, while others like Yahoo! (Nasdaq: YHOO  ) were earning a few cents per share. What mattered was that idle cash was useless because it was underperforming a rising market.

Patient, value-focused investors, on the other hand, waited -- with their cash -- for the excess to play out before making a move. Remember all those Internet mutual funds with triple-digit returns in 1999 and 2000? They soon discovered the results of chasing momentum with staggering losses when the bubble burst.

When you focus on absolute returns, your approach is guided by the availability of undervalued investments. If no bargains exist, then cash is your best friend.

Warren Buffett endured ridicule during the Internet bubble for not joining the party. Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) was spotlighted for its "relative underperformance" during the dot-com boom, because it didn't use its enormous cash pile to chase easy profits. Then, like now, Berkshire seems to be enjoying the last laugh.

You're an investor, not an imitator
While I certainly advocate analyzing what top money managers are buying, one should use this information as an excellent source of ideas. Investors have their own circle of competencies, and for the most part, copying an investor does not produce similar results.

Take those ideas and analyze them yourself. If you like what you see and can understand why it is a good undervalued company, you can then take advantage of the opportunity. Just never forget that imitation will take you only so far.

Further Foolishness:

Read/Post Comments (0) | Recommend This Article (4)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Compare Brokers

Fool Disclosure

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 571947, ~/Articles/ArticleHandler.aspx, 10/22/2016 7:49:35 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Today's Market

updated 22 hours ago Sponsored by:
DOW 18,145.71 -16.64 -0.09%
S&P 500 2,141.16 -0.18 -0.01%
NASD 5,257.40 15.57 0.30%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

10/21/2016 4:00 PM
AMZN $818.99 Up +8.67 +1.07% CAPS Rating: ****
BRK-A $215600.00 Down -1375.00 -0.63%
Berkshire Hathaway… CAPS Rating: *****
BRK-B $143.60 Down -0.89 -0.62%
Berkshire Hathaway… CAPS Rating: *****
CSCO $30.15 Down -0.01 -0.03%
Cisco Systems CAPS Rating: ****
YHOO $42.17 Down -0.21 -0.50%
Yahoo CAPS Rating: **