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Baseball Gives a Lesson On Relative Return Limits

Investors don't have to wait 'til next year to back a winner.

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The Chicago Cubs were recently bounced from Major League Baseball's playoffs by the Arizona Diamondbacks. We should have seen it coming. Forget goats and curses. This was all about the numbers. And the numbers said Arizona had the better team. The Cubs and Diamondbacks both won their respective divisions, but those groups were not equal. Arizona topped a strong division, while the Cubs barely won baseball's weakest. In fact, more than a third of baseball's 30 teams had better records than the Cubs'. Clearly, topping a weak group doesn't always equate to absolute strength. And just as important, quality teams are often hidden in the middle of tough groups.

The same is true in investing. We sort funds by similar styles so that we can make apples-to-apples comparisons among peers. Such comparisons are important. But, they should always be set against a backdrop of absolute performance. As the old saying goes, you can't eat relative returns. A glance at the 10-year annualized returns for Morningstar's domestic- and foreign-stock categories shows a range from 15.7% down to 2.3%. In the basement are Japan stock funds. Even the top-rated funds in this category haven't meaningfully compounded capital over time.

At the opposite end of the spectrum are 10 categories in which the typical fund has returned more than10% annually over the past decade. We trolled these waters and found plenty of funds that we think highly of, even though their current rankings and ratings don't appear great.

Michael Breen does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.