The stock market has blasted its way from one record high to another over the past year, which might lead Main Street investors to assume their portfolio also is firing on all cylinders.
Maybe. But not likely.
So why didn’t average investors earn the 14 percent returns posted by the SP 500 last year? Or the 10 percent return achieved by the Dow Jones industrial average?
“The headlines lack context and are misleading because they are based on returns from only the two most visible and widely promoted areas of the market — the SP 500 and the Dow Jones industrial average,” said Andrei Voicu, chief investment officer at Fragasso Financial Advisors, Downtown.
There is a disconnect between the stock market highs and the actual returns that investors are getting because neither the SP or the Dow is available for direct investment. (There are investment products that track the performance of each index, such as exchange traded funds under the symbol DIA for the Dow and VOO for the SP.)
The Standard Poor’s 500 is an unmanaged, capitalization-weighted benchmark that tracks broad-based changes in the U.S. stock market. The index of 500 common stocks is comprised of 400 industrials, 20 transportation, 40 utility and 40 financial companies representing major U.S. industry sectors.
While the Dow is more closely followed, it is made up of only 30 stocks. That means some important companies are left out and others get undue influence, since the average is weighted by stock price — regardless of how big or important a company is.
Curt Knotick, owner of Accurate Solutions Group in Butler, said the average investor couldn’t stand the kind of risk necessary to track the performance of the SP 500.
“Any investor whose overall return closely tracked the SP 500 index would be furious with their financial adviser and demand, rightfully so, to know why so much risk existed in their portfolio,” Mr. Knotick said. “Unfortunately, this is not always apparent until it’s too late. Need we remember 2008?
“The SP 500 only tracks a very specific type of equity in a single geography, which is large cap stocks in the U.S.,” he said. “Thus, the index is nowhere close to being representative for the global financial markets, which provides you with the diversification needed to mitigate downside risk in any one specific market sector.”
Mr. Voicu believes it is all relative.
Returns for a diversified portfolio during the last 10 years still averaged nearly 7 percent, even during the disastrous year of 2008.
“In other words, investors planning for the long term can’t be short-sighted and believe market growth or losses will happen the same way this year or next or the year after,” he said. “For example, many experts believed there was no use in investing in international markets following the dot.com era.
“What happened next? International markets outperformed U.S. markets for six consecutive years from 2002 through 2007 by an average of 7 percent per year. Imagine what happened to investors who pulled their assets out of international markets?”
Charlie Smith, principal and chief investment officer at Fort Pitt Capital Group in Green Tree, offered another take on why average investors don’t get the returns they see major stock indexes reporting in the news.
“Chances are if an investor is under-performing the SP 500 or the Dow over the last several years, it’s because they’re holding cash and not fully invested in stocks,” he said. “There could be other reasons for under-performance as well.
“Timing may be an issue, particularly for people who sold everything in the panic of 2008 to 2009 and didn’t buy back into the market soon enough.
“We have clients who, despite our best advice, sold everything in late 2008 or early 2009 and then dithered in returning to the market. They’ve been fighting the mathematics ever since.”
Tim Grant: firstname.lastname@example.org or 412-263-1591.