I was bored at work and started crunching numbers on the annualized rate of return of the market as a whole. I used the ^DJI beginning in March of 1929 and went all the way through yesterday’s close. I only came up with a 4.79% return I double checked it by using the PV and FV methods…PV being 311.59, n=76, rate=4.79%
It gave me 10,911 …so what’s the deal with this average of 10%?? Does it have to do with dividends and splits??
i’m confused
The DJIA is compsed of <out of memory> 30 or so Blue Chip stocks that are meant to “represent” the market as a whole. They are in no way indicative of all the publicly traded stocks (I should know, I’ve worked for several of the losers).
There are a lot of companies that have gone from lofty heights to zero that were never considered in the DJIA.
Dividends, yes. Splits, no. The DJIA already takes splits into account.
But dividends account for a significant portion of the return from common stocks, especially in earlier eras when the average dividend yield was higher. Add in and reinvest dividends and you’ll get the long-run 10% return that people cite.
One very important factor:
The DJIA hasn’t been the same group of stocks since 1929, and the divisor is adjusted every time the composition is changed to maintain continuity (adjustments to the divisor are also made to compensate for splits and large dividend payouts). The new members are probably issues which have shown strength - they likely did a major part of their growth while not members of the index. On the other hand, the losers that are booted off have probably underperformed before they are removed.
For instance, AT&T (T), Eastman Kodak (EK), and International Paper (IP) were removed in 2004. Verizon (VZ), AIG and Pfizer (PFE) were added.
You would get a better picture by picking out a represenative group of issues that have been around since 1929, and tracking them, not forgetting to account for splits and dividends. If you invested exactly as a mirror of the DJIA, it would force you to buy and sell issues at non-optimal times to reflect its changing membership.
I believe that General Electric is the only stock that has been part of the Dow Index since it was first tabulated.
This is true, and the original list had 12 members:
http://www.davidstuff.com/financial/dow12.htm
General Electric was removed for several months in 1898, though, so nobody has maintained absolute continuity:
http://www.cftech.com/BrainBank/FINANCE/DowJonesAvgsHist.html
There’s been 30 companies since 1928, and GM has been on it since then.
Before somebody picks the nit, I guess that means GE has NOT been on “since it was first tabulated”. It’s more correct to to say it’s the only original member still on the index.
The original quesion has been answered. The difference between your approximately 4% return and the 10% return you see cited is mostly dividends. The other factor is I don’t believe you see people use March 1929 as the initial point. The stock market crashed in September 1929 and it was very high before that in that year. Most studies look back to December 1925 (when the CRSP data start) or look at the post-war period. Bot of those will give you higher returns for stocks than your strating point.
I’d just like to point out one other thing which has been alluded to here. Many people say things, like “You can’t but the averages.” Despite all the splits, additions and deletions, the DJIA does in fact represent a return (or since dividends are excluded) a capital gain you could have earned. To replicate the DJIA with an actual portfolio, you want to invest dollars in proportion to the price per share. That is. If stock A and B sell for $20 and $60 per share you want to invest 3 times as much in B as A. This can be done by buying one share of each to start. After a split or a substitution of stocks in the index, you’d have to rebalance things.
And of course, you really wouldn’t want to throw the dividends away, so you should reinvest those when receieved in the same price proportions.
The S&P 500 index by the way is weighted by total market value. That is, if all the equity of Microsoft is 100 times as much as all the equity of eBay (I have no idea), you want to invest 100 times as much in Micorsoft. Note that not everyone could replicate the DOW as I suggest, but everyone could replicate the S&P.