Friday, September 3, 2010

Dispelling The Stock Index Chart Myth

Stock Index charts that show that the stock market always going up is total bull crap! Below are a couple example of the Dow Jones and S&P 500 charts over the past 50 and 100 years.


Looking at these charts you would think that yes, over any 20-30 years span the market always is trending upwards. But the truth of the matter, is that these charts don't show you what your portfolio would really look like, if you actually held onto all the original stocks. You would actually be broke.

Of the original 12 DOW Jones stock, only one is still in existence today. That is General Electric. All other companies have failed or merged into other companies. The components of the DJIA have changed 48 times in its 114 year history. The DJIA only has 30 stocks, so it has had over 160% turnover rate. So if anyone actually held onto the original 12 stocks, where do you think they would be today? Only holding GE stock, which is up over the last 50 years but flat for the past 15 years..

In June 8, 2009 GM and Citigroup were removed from the Dow average. Less then a year earlier, AIG, Chevron and Bank of America were replaced. Other companies that have been replaced include Kodak, International Paper, Goodyear, Sears, Bethlehem Steel, Woolworth, American Can, US Steel and Chrysler.

Imagine 20 years ago having a portfolio of Dow Stocks that had GM, Citigroup, AIG, Bank of America, Kodak, Sears and Chrysler? You would be broke now! The fact of the matter is that the current DJIA and S&P are actually just the a collection of the top 30 or top 500 stocks in the market to date. If a company gets to small or goes bankrupt, they just replace it with the next biggest, healthy and stable company.

So any historical chart of these indexes are really misleading. Instead of showing a chart of the original stocks over time. They are actually showing the top stocks of the market at that time, as as a company goes out of business, its replaced with a healthy company until that company goes out of business. The fact that it kinda goes up, over time, shows you the effect of inflation and an increase in money supply.

The truth of the matter is that if you hold onto any stock to long. The odds are it will look like Kodak's stock chart below. After an initial spurt of growth, it returns to zero. The lesson here is to play the upswings, but never stay invested to long...

No comments: