The Dow Jones Industrial Average: 8% per Year?

While there is no doubting the last couple of years have been really great years for the stock market (if you think of it in terms of the growth over the year, rather than growth from many years past), but we’d like to take a moment and think of things a tad longer term.

But keeping with our traditional habit of raining on parades, we wanted to take a moment to point out that not all that glitters is necessarily gold. We’ve talked before about where the Dow Jones Industrial Average would need to be in order to have achieved an 8% per year rate of return since 2000, and figured it was about time that we updated those numbers.

The answer: 31,882.15. A far cry from the 16,469.99 it finished out at for 2013.

The Actual Return

The compound annual growth rate of the Dow Jones Industrial Average since 2000 is about 2.65%. That includes 2013’s magnificent year. So while many of you are whining about the painfully low yields found in fixed income assets, keep in mind that the relative yield isn’t too bad at all.

So where is the 8%?

Here’s the problem with the rates of returns that we often see touted by the investment industry, the start date matters…a lot. If I go all the way back to 1990, I can get 8% (about 8.05% to be exact), but that also requires a 23 year investment period, which is far longer than the average American has spent saving for retirement. And while I don’t doubt that many people could have benefited from that bull market, let’s not forget that practically no one gets in at the ground floor.

We have Another Problem

But the paltry yield boasted by America’s bluest of the Blue Chips isn’t the only disappointing stat coming out of this story. We have to keep another thing in mind. The DJIA has swapped companies that composed the index thirteen times since 2000.

For those of you who don’t know, the major stock market indexes take form by companies that are deemed representative of the segment of the economy they seek to depict. And this representation is usually all about who is doing the best. The DJIA itself is a collection of the 30 best performing blue chips in the American economy. So, whenever a current DJIA listed company fails to maintain it’s good business fortune, it gets replaced by a different and better performing company, and that knew company becomes part of the index instead.

Hopefully, most of you already see the inherent problem this poses to buy-and-hold investor.

Tell Me How…

From time to time a market shrill will show up here at the Insurance Pro Blog and start to explain to us idiots that “if you invested in the market you’d be better off.” And I always ask them how exactly they intend to do such a thing.

No, this question is a blatant display of my ignorance or lack of intelligence (I assure you I know quite a bit about investing in stocks, and I’m sort of proving it in some fashion here) but rather a challenge that underscores the major point I’m making at this very moment.

Since the index itself is magically changed when one company falls out of favor to another, how exactly does one just swap out a position in one company for another? Sure there are many ways to accomplish this in reality, but none of them bear the same consequences (virtually none) that the DJIA—or any other index—faces when done in practice there. In other words YMMV. And put more precisely your mileage will go down.

DJIA 2000 to 2013Dow Jones Industrial Average

So let’s pretend that you did, in fact, go all in on January 1st of 2000 (actually it was January 3rd as that was the first trading day). You eeked out 2.65% (maybe, but probably not) all the while being whipped around from busts following your investment, booms leading up to 2008, and then we all know what happened after that. Was it worth it?

I can’t give you an answer to that question. But I do know this. On January 3rd, 2000 the 20 year treasuries were paying 6.94%, and 10 years 6.58%. Do you even want to hazard a guess what that does for bond par values given today’s interest rates?

I also know that while I can’t go all the way to 2013, because I don’t have the data, the calculated CAGR from this example is just over 7% and it has loads of liquidity neither stocks nor bonds can bring to the table. And if I wanted to be a jerk about it, I could point out that as of 2009, the DJIA’s CAGR was -1.25%.


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