Dow Jones, and S&P 500 averages are often cited to show that stocks are in general a good investment.
The stocks that are the basis of these market average indicators change over time though. It may cease to exist through failure (at least enough that exchange delists it) or mergers, or may drop so much that it is removed because it no longer fits the profile of the type of stock the average is supposed to represent. (“blue chips” or whatever)
I know that the averages account for splits, but when a company is removed from the average, and replaced by another, is there a mechanism that attempts to correct the “return” an investor would see if he had a portfolio that exactly matched that used for the benchmark?
In other words, say GM is removed from the S&P 500, and replaced with Joe’s Pharmaceutical. An actual investor would need to sell their GM stock and use the proceeds to buy JoePharm to keep their portfolio tracking the S&P. (never mind his borker’s fees) Is this accounted for somehow, or do they just swap in the better stock, and S&P blips upward as a result?
If the latter, it seems to me that claims such as “Over the long term, the S&P has beat inflation by X% / year” are worthless. Sure, if you keep dumping companies that are poor performers, and replacing them with better ones, then of course the returns are going to be decent, but do the averages account for the losses an investor would accrue by dumping those poor performers?
ETA…borkers…heh, I think I’ll leave that one!