Many years ago, I played high school baseball. I was a light-hitting infielder with a weak arm, but I was decent at scooping up ground balls. Our coach, a former college player, had a magical touch with a fungo bat; he could make a baseball dance—hard grounders, towering pop flies, with spins that would exaggerate the ball’s movement. On one windy, cloudless spring day, he decided to test us with his aerial arsenal. The baseballs seemed to defy physics, often falling harmlessly to the ground. Each miss was met with a loud "Eeeeeeeeeee" (short for error), and you'd quickly find yourself benched. We all quickly came to appreciate that our coaches would not tolerate excess errors.
A few years later, when I first started in the investing business, my job was to take stock, bond, and options trades from clients over the telephone. This was the early 1990s, before most investors could buy or sell stocks from their personal computers or mobile devices. I was literally a middleman between the customer and the back office trading desks that actually transmitted the orders to the appropriate exchange or market. One particular month, during a time that we were extremely busy, I was working double shifts for overtime pay and made a few mistakes. Those trade errors wound up costing the company money, and subsequently I received coaching from my manager about how damaging errors are to the customer’s trust and the company’s bottom line. That only reinforced my belief that errors are just as bad, if not worse, in investing than they are in baseball.
But what if I told you that in investing, some errors are not just acceptable but desirable? Here, I'm talking about "tracking error," a term that, if properly understood, can make you a better investor.
