When Apple replaced AT&T in the Dow Jones Industrial Average recently, all previous performance for this commonly cited investment index became even less relevant.
The Dow serves as a barometer for the broad market, even though it includes just 30 stocks of giant U.S. companies considered to be industry leaders.
Every time the constituents of the index change, the past returns become less meaningful. Many people look to past returns and extrapolate an estimate of future returns. For example, the Dow has produced 8% average annual price appreciation over the past 25 years. Therefore, that is what we expect it to produce for the next 25 years.
But past performance is not indicative of future results, and it can be dangerous to count on it anyway.
"For past averages to be meaningful, the data being averaged must be drawn from the same population," writes Bradford Cornell , professor emeritus at UCLA's Anderson School of Management, in his book,The Equity Risk Premium . "If this is not the case - if the data comes from populations that are different - the data are said to be non-stationary … projecting past averages typically produces nonsensical results."
The exactness of past performance, documented in many forms - annual returns, average returns, standard deviation of returns, rolling returns, risk-adjusted returns - is misleading when derived from any investment or benchmark that no longer exists in the same form.
Consider what the Dow return would have looked like if Apple ( AAPL ) had joined the index in 2008 instead of Bank of America ( BAC ) - which left the index in 2013. According to a report from Bloomberg News , Apple's strong stock growth would have taken the index higher than its recorded level: As of March 10, the Dow would have hit 21,944, some 4,300 points more. Apple stock , on the strength of the iPhone and other hit products, climbed sevenfold since 2008. On the other hand, BofA got battered in the financial crisis - its shares are down 60% since March 2008.
The Dow adds and subtracts irregularly.
In and out of the Dow (the past six changes):
Date of change
March 19, 2015
September 23, 2013
Alcoa, Bank of America, Hewlett-Packard
Visa, Nike, Goldman Sachs
September 24, 2012
June 8, 2009
Citigroup, General Motors
Cisco Systems, The Travelers
September 22, 2008
American Intl Group ( AIG )
February 19, 2008
Bank of America, Chevron
Criticism of the Dow often revolves around its use of its members' stock prices to measure market changes. Also, detractors say its small size makes it less representative of the market than the more widely used Standard & Poor's 500, which has more stocks and is weighted by market value.
More significantly, though, each change in its population makes previous returns less useful for future comparison. And as the Bloomberg analysis shows, selection of which companies are in the index makes a tremendous difference.
Consider IBM ( IBM ). The iconic tech giant has been in the Dow, out and back in. IBM got removed from the Dow in 1939 and added back in 1979. According to Eddy Elfenbein , editor of the Crossing Wall Street newsletter , over that time, IBM gained 22,000%. "If IBM had remained in the Dow, the index would have had nearly twice the value."
This isn't a phenomenon of the Dow. Motley Fool columnist Morgan Housel recently wrote an article looking at the S&P 500 and how it has seen over 1,000 companies enter and exit the index over the years.
Companies die. Companies shrink in relation to the size of the market, their industry or the overall economy. Industry leadership rotates during different environments. Many variables - including global developments, consumer demographics, shifts from manufacturing to service economy, technology advancement, corporate taxation, currency values - change the characteristics of any benchmark over the years.
What the S&P 500 returned in 2014, since 2000 or any other time frame provides a point of reference, but it doesn't tell us anything really of what the next year or decade's returns will be.
Rather than focusing on whether or not your investments kept up with an appropriate benchmark, it's more important to first trust that you are implementing a quality investment process and that your future savings are commensurate with the size of your future goals. While everything else around you is changing, these are two things that you can control.
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Gary Brooksis a certified financial planner and the president ofBrooks, Hughes & Jones, and a registered investment adviser in Tacoma, Wash. An expanded version of this piece first ran at his blogThe Money Architects.
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