The best way to outperform a mutual fund is not to think like a mutual fund.
Many investors have come to believe that the mutual fund model is the best way to produce superior returns and they therefore should operate as a small version of a giant fund.
Why would any individual investor believe they can perform better than a fund that has a huge research staff, spends many millions on research and is very likely to have inside contact with management at major companies? Can an individual investor managing a few hundred thousand dollars in capital do better than a mutual fund when they employ the same strategy?
Individual investors tend to fall into this trap because they like to believe they possess some special insight that giant firms do not. They want to believe they have a special skill that will allow them to pick stocks better than fund managers who have research abilities that are exponentially greater.
The typical approach of most large funds is to identify a stock they deem to be fundamentally superior and then buy it at the lowest price possible. When the stock price declines they will lower their cost bases by buying more. They stay with the stock as long as their fundamental beliefs are intact. They don't use stops nor do they rely much on charts or technical issues. Most funds will seldom have high levels of cash. When the market goes through a rough patch like it did in October, they may only have 10% or less in cash.
That model may work well for a fund with billions of capital to invest and the ability to do very deep research, but why would an individual choose to do the exact same thing and hope to beat the fund?
The answer to that question is that most small investors don't have any idea what approach might work better. The mutual fund model is what they are taught and institutional Wall Street constantly promotes it as the best approach.
The reality is that the great advantage small investors have over big funds is their flexibility. They can enter and exit positions in the blink of an eye. If something isn't working they can escape quickly, and if something is working they can add to the position with a couple keystrokes. They can sit in cash in bad markets and put it back to work when conditions improve.
Mutual funds are big and slow-moving. They can't react to price action. They must focus on trying to predict the future. When the market acts poorly they have little choice but to ride it out and hope things improve soon
If you want to consistently beat mutual funds you should view the market much differently than the way a fund manager does. There should be much more focus on price action. Fundamentals may still be a primary focus, but they must be considered in the context of price action.
The single best thing an individual investor can do to beat mutual funds is to focus on keeping their accounts as close to highs as possible. When losses start to mount, hurry to sell and sit in cash. Making up unrealized losses is one of the most unproductive things you can do in investing, and that is what dooms most funds that have no choice but to ride out weakness.
Developing an effective way to manage your positions is a subject that would fill a book, but the essence of outperformance is to use your unique advantages as a small investor. Don't try to compete with a fund by doing the exact same things that they do. That will doom you to mediocrity.
If you wanted to compete in the retail business, would you do exactly what Amazon (AMZN) does? No one would realistic believe they could beat Amazon using the same model. They would have to come up with a different approach in order to succeed. That is how individual investors need to think if they want to beat a mutual fund.