I really enjoy looking at the historical performances of various stock market indices. It helps me form my big-picture outlook on the trajectory of the stock market over the course of a year or so.
As most investors know, the stock market has always gone up over the long term. But you have to take this accepted truth with a grain of salt. The key term here is “the stock market”. In almost all instances when looking at long-term historical performance of the stock market, the data refers to one of the big 3 stock market indices: the Dow Jones Industrial Average (DJIA), the S&P 500 index (S&P 500), and/or the NASDAQ 100 index (NASDAQ 100).
These indices track a basket of individual stocks. The DJIA tracks 30 stocks that are leaders in their respective industries. The S&P 500 tracks the 500 largest publicly traded companies in the United States and the NASDAQ 100 tracks the 100 largest companies listed on the NASDAQ exchange.
The problem here is that the companies that these indices track are periodically changed, depending on the index’s criteria. Typically, what happens is when a company has been performing poorly and/or has shrunk in value, they are replaced with another company that has been doing well and growing. Basically, the indices get rid of their losers and replace them with winners. So, naturally, the performances of the indices are going to be skewed higher.
Of course, this isn’t the only reason these indices seem to always go higher over the long term. Our country is growing. Our companies are serving more of the world and are becoming more efficient and profitable. Our GDP continues to expand as well. It’s just something to consider when looking at historical track records of the stock market.
Please comment or send an email if you have any questions. Thanks!
Joe Baker, CFP®
Baker Asset Management, LLC
